E=J 


Universal' 
Knowledge 
Foundation 


PRINCIPLES  OF  COMMERCE 


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THE  MACMILLAN  COMPANY 

NEW  YORK  •  BOSTON  •  CHICAGO  •  DALLAS 
ATLANTA  •  SAN  FRANCISCO 

MACMILLAN  &  CO.,  Limited 

LONDON  •  BOMBAY  •  CALCUTTA 
MELBOURNE 

THE  MACMILLAN  CO.  OF  CANADA,  Ltd. 

TORONTO 


PRINCIPLES  OF  COMMERCE 


A  STUDY  OF  THE  MECHANISM,  THE  ADVAN¬ 
TAGES,  AND  THE  TRANSPORTATION 
COSTS  OF  FOREIGN  AND 
DOMESTIC  TRADE 


BY 

HARRY  GUNNISON  BROWN 

ASSISTANT  PROFESSOR  OF  ECONOMICS  IN 
THE  UNIVERSITY  OF  MISSOURI 


BOSTON  COLLEGE  LIBRARY 
CHESTXTH1  TOLL,  MASS.  /\ 


Nefri  gctk 

THE  MACMILLAN  COMPANY 

■  •  1923 


All  rights  reserved 


PRINTED  IN  THE  UNITED  STATES  OF  AMERICA 

1 


Copyright,  1914  and  1916, 

By  THE  MACMILLAN  COMPANY. 


Set  up  and  electrotyped.  Published  July,  1916. 


Nortnooti 

J.  S.  Cushing  Co.  —  Berwick  A  Smith  Co. 
Norwood,  Mass.,  U.S.A. 


PREFACE 


In  writing  a  book  on  the  Principles  of  Commerce ,  my 
purpose  has  been  to  present  the  theory  of  commerce  in 
its  several  important  aspects,  while  yet  so  emphasizing 
the  relations  of  the  different  branches  of  the  subject  to 
each  other,  as  to  give  unity  to  the  whole.  In  accord¬ 
ance  with  this  purpose,  the  book  has  been  written  in 
three  Parts  (separately  paged),  viz.,  (i)  The  Exchange 
Mechanism  of  Commerce ;  (II)  The  Economic  Advan¬ 
tages  of  Commerce ;  and  (III)  The  Transportation  Costs 
of  Commerce.  Each  Part  has  a  real  and  close  connec¬ 
tion  with  the  Part  immediately  preceding  or  following 
it ;  yet  no  one  Part  is  written  merely  as  an  introduction 
to  or  appendix  to  another.  Each  is  important  in  itself. 

In  Part  I  the  aim  is  to  set  forth  briefly  the  laws  of 
money  and  the  nature  of  banking,  and  then  to  show, 
through  an  analysis  of  foreign  exchange  operations,  the 
international  nature  of  the  credit  relations  growing  out 
of  trade.  In  this  Part,  I  have  endeavored  to  analyze, 
more  fully  than  is  usually  done,  the  interrelations  of 
different  persons,  buyers  and  sellers,  et  a l .,  in  the  credit 
mechanism  of  exchange,  —  to  show  who  are  the  ultimate 
creditors  when  bank  checks  and  bank  notes  are  used  in 
trade  and  when  bills  of  exchange  (especially  “long 
bills  ”)  are  used.  The  flow  of  money  from  country  to 
country  is  explained,  and  the  relation  of  this  flow  to 
fluctuations  in  the  rate  of  exchange.  Emphasis  is 
placed  on  the  fact,  ordinarily  passed  by  without  notice, 
that  whatever  may  be  the  relation  or  non-relation  of  the 


vi 


PREFACE 


currency  of  a  country  to  the  currencies  of  other  coun¬ 
tries,  its  trade  with  them  cannot  all  be  either  an  export 
or  an  import  trade  for  any  great  while,  without  intro¬ 
ducing  a  tendency  to  a  reverse  flow  or  to  equilibrium. 

Part  II  succeeds  logically  to  Part  I.  The  money  and 
credit  mechanism  of  commerce  having  been  described 
and  its  operation  explained  in  Part  I,  Part  II  begins 
with  a  consideration  of  the  gains  of  trade,  whether  the 
trade  is  within  a  single  country  or  between  countries. 
Then  comes  a  discussion  regarding  the  shares  of  two 
or  more  countries  in  the  gains  resulting  from  their  trade 
with  each  other.  Chapter  III  deals  with  the  shifting 
and  incidence  of  revenue  tariffs  on  imports  and  exports. 
In  the  remainder  of  Part  II,  I  have  considered  govern¬ 
mental  interferences  with  and  favors  to  trade,  such  as 
protective  tariffs,  bounties,  navigation  acts,  canal  build¬ 
ing  at  public  expense  without  charge  to  the  users,  land 
grants  in  encouragement  of  railway  building,  etc. ;  and 
have  explained  what  effects  are  to  be  expected  from 
these  various  policies. 

Part  III  begins  with  a  classification  of  the  costs  of 
transportation,  and  a  discussion  regarding  the  extent  to 
which  each  class  of  costs  does  affect  and  ought  to  affect 
rates.  The  various  kinds  of  competition  in  transpor¬ 
tation  are  then  described.  Monopoly  conditions  are 
described,  and  the  effect  of  monopolistic  rates  on  com¬ 
merce  is  discussed.  Various  kinds  of  discrimination 
are  treated  at  length.  In  the  main,  this  third  Part  of 
the  book  is  given  over  to  the  theory  of  transportation 
rates ;  but  transportation  rates  are  here  dealt  with,  pri¬ 
marily,  in  their  relation  to  commerce.  Whether  a  given 
level  of  rates  is  so  high  that,  like  tariff  restrictions,  it 
will  prevent  commerce  which  ought  to  take  place,  or 
whether  it  is  so  low  (less  than  cost)  that,  like  most 


PREFACE 


vu 

bounties,  it  will  encourage  commerce  that  ought  not  to 
take  place,  or  whether  rates  are  discriminatory  in  such  a 
way  as  to  affect  commerce  injuriously,  are  the  questions 
kept  constantly  in  view.  As  a  protective  tariff  may 
prevent  profitable  trade,  so  may  monopolistic  transporta¬ 
tion  rates.  As  the  protective  policy  may,  perhaps,  ben¬ 
efit  persons  in  one  section  of  a  country  at  the  expense 
of  those  in  another  section,  so  discriminating  transporta¬ 
tion  rates  may  arbitrarily  build  up  one  city  and  ruin 
another.  As  tariff  protection  may  divert  a  country’s 
industry  out  of  its  most  profitable  channels,  so  may  dis¬ 
criminating  railroad  rates  arbitrarily  encourage  one 
industry  in  a  given  territory  or  section  and  discourage 
another.  As  tariff  barriers  may  further  the  develop¬ 
ment  of  private  monopoly,  so  may  discrimination  in 
rates  among  competing  shippers.  Yet,  on  the  other 
hand,  certain  apparent  discriminations  among  places, 
among  different  kinds  of  goods,  and  between  different 
directions,  are  seen,  upon  analysis,  to  be  not  quite  analo¬ 
gous  to  protective  tariffs  and  bounties,  but  to  be,  within 
limits,  economically  defensible. 

The  book  has  been  written  with  both  the  general 
reader  and  the  student  in  view.  My  hope  is  that  it  may 
be  found  useful  in  general  courses  of  commerce,  in 
courses  dealing  with  foreign  and  domestic  exchange  and 
trade,  or  in  courses  dealing  with  trade  and  trade  re¬ 
strictions  and  the  relation  of  transportation  rates  to 
trade.  Perhaps,  also,  where  no  undue  anticipation  of 
other  courses  results,  it  may  serve  as  a  second  book  in 
general  courses  on  economics,  following  a  more  elemen¬ 
tary  introductory  text.  The  range  of  topics  treated  and 
the  interest  of  many  of  these  topics  to  the  average  stu¬ 
dent  would  seem  not  unfavorable  to  such  use.  Clear¬ 
ness  has  been  particularly  aimed  at.  The  discussion  of 


/ 


i 


PREFACE 


•  •• 
Vlll 


difficult  or  controversial  questions  of  particular  interest 
to  professional  economists  has  been  largely  relegated 
to  footnotes. 

Acknowledgment  should  be  here  made  of  various 
courtesies  extended,  and  of  the  aid  rendered  me  by  a 
number  of  friends  who  have  done  much  toward  remov¬ 
ing  errors  of  statement  and  expression  and  in  suggest¬ 
ing  the  addition  of  critical  and  illustrative  matter.  To 
the  Quarterly  Journal  of  Economics  I  am  under  obliga¬ 
tion  for  permission  to  include,  in  Chapter  II  of  Part  I, 
substantially  without  change,  the  text  of  an  article  on 
Commercial  Banking  and  the  Rate  of  Interest ,  originally 
published  in  August,  1910.  To  the  American  Economic 
Review  I  owe  permission  to  republish,  as  Chapter  II  of 
Part  III,  in  practically  its  original  form,  an  article  on 
The  Competition  of  Transportation  Companies ,  first  pub¬ 
lished  in  that  periodical  in  December,  1914.  To  Brown 
Bros.,  of  New  York  City,  I  am  indebted  for  several  items 
of  needed  information  regarding  foreign  exchange  meth¬ 
ods,  and  both  to  Brown  Bros,  and  to  Mr.  Jacob  Seibert, 
Jr.,  editor  of  the  Commercial  and  Financial  Chronicle ,  I 
am  indebted  for  detailed  information  on  a  number  of 
points  connected  with  the  recent  foreign  exchange  situ¬ 
ation,  —  information  which  made  it  possible  to  illustrate 
(Part  I,  Chapter  VI,  §  9),  by  reference  to  current  events, 
conclusions  which,  in  my  International  Trade  and  Ex¬ 
change  (1914),  were  presented  as  purely  theoretical,  but 
which  appear  to  have  been  verified  by  occurrences  grow¬ 
ing  out  of  the  European  war.  To  one  of  my  students, 
Mr.  Lawrence  M.  Marks,  Yale  1914,  I  am  indebted  for 
the  calculation  of  seasonal  sterling  exchange  rates,  pre¬ 
sented  as  a  footnote  in  Chapter  IV  (§  2)  of  Part  I.  Mr. 
Franklin  Escher,  of  the  Commercial  Security  Company, 
New  York  City,  has  given  me  the  benefit  of  a  careful 


PREFACE 


ix 


criticism  of  the  manuscript  of  Part  I,  particularly  regard¬ 
ing  the  matter  of  conformity  of  statement  to  business 
practice.  To  Professor  F.  R.  Fairchild  of  Yale  College 
I  am  indebted  for  a  searching  criticism  of  Part  I,  from 
the  standpoint  both  of  economic  theory  and  of  form  of 
presentation.  The  late  Professor  G.  S.  Callender  of  the 
Sheffield  Scientific  School,  Yale  University,  to  whom  I 
submitted  the  manuscript  of  Part  II,  made  a  number  of 
valuable  criticisms  and  suggestions.  On  Part  III,  I 
have  to  acknowledge  a  most  searching  and  valuable 
criticism  by  Professor  John  Bauer  of  Cornell  University. 
I  am  also  indebted,  for  critical  reading  of  selected  chap¬ 
ters  in  Parts  II  and  III,  to  Professors  Irving  Fisher, 
Clive  Day,  and  H.  C.  Emery  of  Yale  College.  Finally, 
I  would  acknowledge,  here,  the  aid  rendered  by  my 
wife,  who  has  assisted  me  in  the  gathering  of  data,  in 
reading  and  criticising  the  entire  manuscript  in  its 
various  stage”  of  completion,  and  in  correcting  the 
proof. 

HARK*  GUNNISON  BROWN. 

Columbia,  Mo., 

March,  1916. 


GENERAL  SUMMARY 


PART 

I. 

THE 

EXCHANGE  MECHANISM 

OF 

PAGES 

COMMERCE  .... 

• 

I-I54 

PART 

II. 

THE 

ECONOMIC  ADVANTAGES 

OF 

COMMERCE  .... 

• 

3-188 

PART 

III. 

THE 

TRANSPORTATION  COSTS 

OF 

COMMERCE  .... 

• 

3-I92 

SUMMARY  BY  CHAPTERS 


PART  I 

THE  EXCHANGE  MECHANISM  OF 
COMMERCE 

CHAPTER 

I.  Laws  of  Money . . 

II.  The  Nature  of  Bank  Credit  .... 

III.  The  Nature  and  Method  of  Foreign  Exchange 

IV.  The  Rate  of  Exchange . 

V.  The  Rate  of  Exchange  and  the  Flow  of 
Specie . 

VI.  Further  Considerations  Regarding  the  Rate 
of  Exchange  . 

PART  II 

THE  ECONOMIC  ADVANTAGES  OF 
COMMERCE 

I.  Prices,  Intercommunity  Trade,  and  the 
Gains  of  Trade . 

II.  The  Rate  of  Interchange  of  Goods  between 
Communities . 

III.  The  Incidence  of  Tariffs  for  Revenue 

IV.  The  Effect  of  a  Protective  Tariff  on  Na¬ 

tional  Wealth . 

V.  The  Effects  of  Protection  on  the  Distribu¬ 

tion  of  National  Wealth  among  Eco¬ 
nomic  Classes  and  among  Territorial 

Sections  ....... 

xiii 


PAGES 

1-25 

26-50 

51-76 

77-102 

103-125 

126-154 


3-18 

19-38 

39-56 

57-85 


86-115 


XIV 


SUMMARY  BY  CHAPTERS 


CHAPTER  PAGES 

VI.  A  Consideration  of  Some  Special  Argu¬ 
ments  for  Protection  ....  116-143 

VII.  The  Nature  and  Effects  of  Bounties.  .  144-154 

VIII.  Uneconomical  Government  Interference 
With,  and  Encouragement  of,  Trans¬ 
portation  .  155-188 

PART  III 

THE  TRANSPORTATION  COSTS  OF 
COMMERCE 

I.  The  Cost  of  Transportation  .  .  .  3-36 

II.  The  Competition  of  Transportation  Com¬ 


panies  .  37-70 

III.  Transportation  Monopoly  ....  71-93 


IV.  Economically  Undesirable  Rate  Discrimi¬ 
nation  among  Places . 94-119 

V.  Economically  Defensible  Discrimination 

among  Places . 1 20-1 59 

VI.  Relative  Rates  on  Different  Goods  .  .  160-174 

VII.  Discrimination  among  Shippers  .  .  .  175-192 


CONTENTS  BY  SECTIONS 

PART  I 

THE  EXCHANGE  MECHANISM  OF 
COMMERCE 

CHAPTER  I 

Laws  of  Money . 

§  1.  Quantitative  Statement  of  the  Relation  between 
Money  and  Prices.  §  2.  Causal  Explanation  of  the  Price 
of  a  Given  Kind  of  Goods.  §  3.  Causal  Explanation  of 
the  General  Level  of  Prices.  §  4.  Causal  Explanation 
of  the  Value  or  Purchasing  Power  of  Money,  the  Recip¬ 
rocal  of  the  Level  of  Prices  of  Goods.  §  5.  The  Theory 
of  Bimetallism.  §  6.  The  Value  of  Subsidiary  Money. 
§  7.  The  Value  of  Money  as  Related  to  the  Value  of  a 
Standard  Money  Metal.  §  8.  The  Level  of  Prices  and 
the  Value  of  Money  in  One  Country  or  Locality  as  Re¬ 
lated  to  the  Level  of  Prices  and  the  Value  of  Money 
in  Another.  §  9.  Summary. 


CHAPTER  II 

The  Nature  of  Bank  Credit . 

§  1.  How  and  When  Credit  Takes  the  Place  of  Money. 
§  2.  How  Commercial  Banking  is  Carried  On.  §  3.  An¬ 
alysis  of  Relations  Involved  in  Commercial  Banking. 
§  4.  Why  Commercial  Banking  Commends  Itself  to 
Business  Men,  both  as  Lenders  and  Borrowers,  so  that 
Commercial  Bank  Credit  becomes  a  Substitute  for  Money. 

xv 


PAGES 

1-25 


26-50 


I 


xvi 


CONTENTS  BY  SECTIONS 


PAGES 

§  5.  Application  of  Principles  Arrived  at,  to  Bank  Notes. 

§  6.  Quantitative  Statement  of  the  Relation  of  Money, 
together  with  Bank  Credit,  to  Prices.  §  7.  Fluctuations 
of  Bank  Credit.  §  8.  Summary. 


CHAPTER  III 


The  Nature  and  Method  of  Foreign  Exchange.  .  51-76 


§  1.  The  Function  of  Bills  of  Exchange.  §  2.  The 
Nature  of  Bills  of  Exchange.  §  3.  How  Bills  of  Ex¬ 
change  Might  be  Used  to  Settle  Obligations,  Assuming  no 
Banks.  §  4.  Settlement  of  Obligations  by  Drafts  (Bills 
of  Exchange),  through  Intermediation  of  Banks,  Assum¬ 
ing  Creditors  to  Draw  Drafts  on  Debtors.  §  5.  Settle¬ 
ment  of  Obligations  by  Bank  Drafts,  when  Debtors  Remit 
to  Creditors.  §  6.  How  Exchange  Banks  Make  Profits. 
§  7.  Various  Types  of  Drafts.  §  8.  The  Sale  of 
Demand  Drafts  against  Remittances  of  Long  Bills. 
§  9.  Summary. 


CHAPTER  IV 


The  Rate  of  Exchange . 77-102 

§  1.  The  Meaning  of  Par  of  Exchange.  §  2.  The  Supply 
of  and  the  Demand  for  Bills  of  Exchange.  §  3.  The 
Effect  on  the  Exchange  Market  of  any  Country  of  Dis¬ 
turbed  Political  or  Industrial  Conditions  in  That  Country, 
and  in  Other  Countries.  §  4.  Analysis  of  the  Relations 
Involved  in,  and  Explanation  of  the  Results  of,  Short 
Time  Loans  Made  Ostensibly  by  Foreign  Banks,  through 
the  Intermediation  of  the  Exchange  Market.  §  5.  Fi¬ 
nance  Bills,  What  they  Are,  Whose  Accumulations  Make 
them  Possible,  and  What  are  their  Results.  §  6.  How 
a  Bank  in  One  Country  and  a  Bank  in  Another  May, 
through  the  Aid  of  the  Exchange  Market,  Invest  in  One 
of  the  Countries  for  Joint  Account,  without  Either  Bank 
Using  Its  Own  Funds.  §  7.  Analysis  of  the  Relations 
Involved  in  a  Letter  of  Credit.  §  8.  Place  Speculation 
or  Arbitraging  in  Exchange.  §  9.  Time  Speculation  in 
Exchange.  §  10.  Summary. 


CONTENTS  BY  SECTIONS 

CHAPTER  V 

The  Rate  of  Exchange  and  the  Flow  of  Specie 

§  1.  The  Upper  Limit  to  Fluctuation  of  the  Rate  of 
Exchange,  Determined  by  the  Cost  of  Exporting  Specie. 
§  2.  Some  Details  Connected  with  the  Exportation  of 
Specie.  §  3.  The  Lower  Limit  to  Fluctuation  of  the 
Rate  of  Exchange,  Determined  by  the  Cost  of  Importing 
Specie.  §  4.  Circumstances  which  May  Cause  the  Rate 
of  Exchange  to  Fall  Below  what  is  Usually  its  Lower 
Limit.  §  5.  The  Cost  of  Money  Shipment  in  Domestic 
Exchange.  §  6.  The  Long  Run  Effect  of  a  Balance  of 
Payments  from  One  Country  to  Another,  for  Commodities 
or  Services.  §  7.  The  Long  Run  Effect  of  International 
Investments  upon  the  Rate  of  Exchange  and  the  Flew 
of  Money.  §  8.  The  Long  Run  Effect  of  Various  Other 
Payments  from  One  Country  to  Another.  §  9.  Summary. 


CHAPTER  VI 

Further  Considerations  Regarding  the  Rate  of  Ex¬ 
change  . 

§  1.  The  Price  of  Long  Drafts  Determined  in  Part  by 
the  Rate  of  Interest  or  Discount.  §  2.  How  Long  Drafts 
on  Foreign  Countries  are  Held  as  Investments  by  Ameri¬ 
can  Banks.  §  3.  Influence  on  the  Price  of  Long  Drafts, 
of  Interest  Rate  in  Drawing  Country  and  of  Interest  Rate 
in  Country  Drawn  Upon.  §  4.  How  and  Why  the  Bank 
Discount  Rate  Affects  the  Price  of  Demand  Drafts  and 
the  Flow  of  Specie.  §  5.  Effect  of  a  Panic  in  One 
Country  on  Conditions  in  Other  Countries.  §  6.  Ex¬ 
change  between  Two  Countries  when  One  has  a  Gold 
and  the  Other  a  Silver  Standard.  §  7.  Exchange  be¬ 
tween  Two  Countries  when  One  has  a  Gold  and  the 
Other  an  Inconvertible  Paper  Standard.  §  8.  Exchange 
between  Two  Countries  when  Both  have  Inconvertible 
Paper  Standards.  §  9.  Exchange  between  Two  Coun¬ 
tries,  Assuming  Effective  Prohibition  of  Specie  Ship¬ 
ment.  §  10.  The  Effect  on  the  Rate  of  Exchange  of 
High  Import  and  Export  Duties.  §  11.  Summary. 


xvii 


PAGES 

103-125 


126-154 


xvm 


CONTENTS  BY  SECTIONS 


PART  II 

THE  ECONOMIC  ADVANTAGES  OF 
COMMERCE 

CHAPTER  I 

Prices,  Intercommunity  Trade,  and  the  Gains  of 

Trade  . 

§  1.  The  Relation  of  Prices  in  One  Country  to  Prices 
in  Another.  §  2.  What  Prices  Tend  to  be  Lower  in  a 
Given  Country,  than  Prices  of  the  Same  Kinds  of  Goods 
in  Another  Country.  §  3.  Trade  between  Two  Commu¬ 
nities  when  Each  has  an  Absolute  Advantage  over  the 
Other,  in  One  or  More  Lines  of  Production.  §  4.  Trade 
between  Two  Communities  or  Countries  when  One  is 
More  Productive  than  the  Other  in  Several  or  in  All 
Lines,  but  has  a  Greater  Advantage  in  One  Line  or  in  a 
Few  Lines,  than  in  the  Rest.  §  5.  Summary. 

CHAPTER  II 

The  Rate  of  Interchange  of  Goods  between  Com¬ 
munities  . 

§  1.  The  Limits  to  the  Rate  at  which  the  Goods  of 
One  Country  Exchange  for  Those  of  Another.  §  2.  Con¬ 
ditions  of  Supply  and  Demand  Determining  the  Exact 
Rate  of  Interchange  between  these  Limits,  §  3.  Effect 
on  this  Rate,  when  One  of  the  Countries  Offers  a  Variety 
of  Goods  in  Trade,  and  also  when  it  Receives  Periodic 
Payments  of  Obligations  from  the  Other.  §  4.  Influence 
on  Trade  and  the  Rate  of  Trade  of  Production  in  any 
Country  under  Conditions  of  Different  Cost.  §  5.  Ex¬ 
tension  of  Hypothesis  so  as  to  Include  Trade  Involving 
More  than  Two  Countries.  §  6.  Cost  of  Transportation 
as  Related  to  Trade.  §  7.  Summary. 

CHAPTER  III 

The  Incidence  of  Tariffs  for  Revenue 

§  1.  Revenue  and  Protective  Tariffs  Distinguished. 
§  2.  When  the  Burden  of  an  Import  Duty  Levied  for 


PAGES 

3-18 


19-38 


39-56 


CONTENTS  BY  SECTIONS 

Revenue  is  Borne  by  the  Levying  Country.  §  3.  When 
the  Burden  of  an  Import  Duty  Levied  for  Revenue  is 
Shifted  by  the  Levying  Country  to  Another  or  to  Other 
Countries.  §  4.  The  Ultimate  Incidence  of  a  Revenue 
Duty  on  Exports.  §  5.  Summary. 

CHAPTER  IV 

The  Effect  of  a  Protective  Tariff  on  National 
Wealth . 

§  1.  The  Effect  of  a  Protective  Tariff  on  a  Country’s 
Export  Trade.  §  2.  How  a  Protective  Tariff  Sets  Up 
Unprofitable  Industries  at  the  General  Expense.  §3.  The 
Effect  of  Protection  on  the  Money  Prices  of  Protected 
Goods  and  on  the  Money  Prices  of  Unprotected  Goods. 
§  4.  Protection  to  Industries  in  which  Large  Scale  Pro¬ 
duction  is  Advantageous.  §  5.  Protection  to  Industries 
of  Increasing  Cost.  §  6.  Effect  of  a  Country’s  Protec¬ 
tive  Tariff  System  on  the  Cost  to  it  of  Unprotected  Goods 
Got  from  Other  Countries.  §  7.  A  Tariff  “  Equal  to  the 
Difference  in  Cost  of  Production  at  Home  and  Abroad, 
together  with  a  Reasonable  Profit.”  §  8.  Relative  Ad¬ 
vantages  in  the  World’s  Commerce  of  Countries  having 
High  and  Countries  having  Low  or  No  Tariffs. 
§  9.  Summary. 

CHAPTER  V 

The  Effects  of  Protection  on  the  Distribution  of 
National  Wealth  among  Economic  Classes  and 
among  Territorial  Sections . 

§  1.  Effect  of  Protection  on  the  Rate  of  Interest  and 
Therefore  on  Wages.  §  2.  Brief  Statement  of  Laws  of 
Wages  and  Land  Rent.  §  3.  The  Effect  of  Protection 
on  Wages  when  Protected  and  Unprotected  Goods  are 
Produced  in  the  Protectionist  Country,  under  Conditions 
of  Substantially  Constant  Cost.  §  4.  The  Effect  of  Pro¬ 
tection  on  Wages  and  Rent  when  the  Protected  Goods 
are  Produced  under  Conditions  of  Sharply  Increasing 
Cost.  §  5.  The  Effect  of  Protection  on  Wages  and  Rent 
when  Unprotected  Goods  are  Produced  under  Conditions 
of  Sharply  Increasing  Cost.  §  6.  How  Protection  May 


xix 

PAGES 


57-85 


86-115 


CONTENTS  BY  SECTIONS 


n 


Benefit  One  Section  of  a  Country  at  the  Expense  of 
Other  Sections.  §  7.  Protection  as  an  Encouragement 
to  Monopoly.  §  8.  Summary. 

CHAPTER  VI 

A  Consideration  of  Some  Special  Arguments  for  Pro¬ 
tection  . 

§  1.  The  Argument  that  Protection  is  Desirable  Be¬ 
cause  it  Keeps  Money  in  the  Protected  Country. 

§  2.  The  Wages  Argument  for  Protection.  §  3.  The 
Make- Work  Argument  for  Protection.  §  4.  The  Home 
Market  Argument  for  Protection.  §  5.  The  Argument 
for  Protection  to  Agriculture  in  the  Older  Countries, 
against  a  Future  when  Cheap  Foods  and  Raw  Material 
may  not  be  Obtainable  from  the  Newer  Countries. 

§  6.  The  Infant  Industry  Argument  for  Protection. 

§  7.  The  Argument  that  a  Protective  Policy  should  be 
Followed  in  Order  to  Diversify  Industry.  §  8.  The 
Argument  that  Protection  should  be  Applied  as  a  Means 
of  Getting  and  Maintaining  a  Certain  Degree  of  National 
Self-sufficiency.  §  9.  Free  Trade  within  the  United 
States.  §  10.  Ethical  Considerations  Bearing  on  the 
Policy  of  Protection.  §  11.  Summary. 

CHAPTER  VII 

The  Nature  and  Effects  of  Bounties  .... 
§  1.  Bounties  as  Compared  and  Contrasted  with  Pro¬ 
tection.  §  2.  The  Various  Possible  Effects  of  Bounties 
on  the  Level  of  Prices.  §  3.  The  Various  Possible  Ef¬ 
fects  of  Bounties  on  the  General  Welfare  in  the  Bounty¬ 
paying  Country  and  in  the  Countries  with  which  it  Trades. 
§  4.  The  Various  Possible  Effects  of  Bounties  on  Wages 
and  Rent.  §  5.  Why  Bounties  May  be  Less  Objection¬ 
able  than  Protection  if  Encouragement  of  Infant  Indus¬ 
tries  is  in  Any  Case  to  be  Attempted.  §  6.  Summary. 

CHAPTER  VIII 

Uneconomical  Government  Interference  with,  and 
Encouragement  of,  Transportation 

§  1.  Navigation  Laws.  §  2.  Subsidies  to  Native  Ship¬ 
ping.  §  3.  Indirect  Subsidies,  Favoring  Native  Ships 


?AG*S 


116-143 


144-154 


155-188 


CONTENTS  BY  SECTIONS 

as  Compared  with  Foreign  Ships.  §  4.  The  Free  Use, 
for  Navigation,  of  Government-built  Canals.  §  5.  The 
Improvement  of  Harbors.  §  6.  The  Improvement  of 
Rivers.  §  7.  Subsidies  to  Railroad  Building.  §  8.  Sum¬ 
mary. 

PART  III 

THE  TRANSPORTATION  COSTS  OF 
COMMERCE 

CHAPTER  I 

The  Cost  of  Transportation . 

§  1.  Preliminary  Remarks  on  the  Expenses  of  Rail¬ 
roads.  §  2.  Classification  of  the  Expenses  of  Rail  Trans¬ 
portation.  §3.  Influence  which  these  Various  Expenses 
Have  and  Should  Have  on  the  Determination  of  Rail¬ 
road  Rates.  §  4.  Average  Railroad  Rates  as  Affected 
by  Degree  of  Utilization  of  Railroad  Capital.  §  5.  Ex¬ 
penses  and  Rates  of  Water  Transportation.  §  6.  Com¬ 
parative  Importance  of  General  Expenses  and  Fixed 
Charges  on  Railroads,  on  Natural  Waterways,  and  on 
Canals.  §  7.  The  Proper  Basis  of  Wharf  Charges. 
§  8.  Economic  Objections  to  Monopolistic  Transporta¬ 
tion  Rates.  §  9.  Summary. 

CHAPTER  II 

The  Competition  of  Transportation  Companies  . 

§  1.  Competition  of  Routes.  §  2.  Circumstances  which 
May  Make  Carriage  of  Goods  by  a  Longer  Route  More 
Economical  than  their  Carriage  by  a  Shorter  Route. 
§  3.  Competition  of  Directions.  §4.  Competition  of 
Locations.  §  5.  Competition  against  Potential  Local 
Self-sufficiency.  §  6.  Two  Senses  of  “  What  the  Traffic 
Will  Bear.”  §  7.  Summary. 

CHAPTER  III 

Transportation  Monopoly . 

§  1.  Monopoly  of  Rail  Transportation.  §  2.  Agree¬ 
ments  between  Navigation  Companies.  §  3.  Other 


xxi 

PAGES 


3-36 


37-70 


71-93 


xxu 


CONTENTS  BY  SECTIONS 


PAGES 

Causes  of  Monopoly  in  Water  Transportation.  §  4.  The 
Function  of  Government  in  Relation  to  Transportation 
Monopoly.  §  5.  Summary. 

CHAPTER  IV 

Economically  Undesirable  Rate  Discrimination 

among  Places . 94-119 

§  1.  Competition  as  a  Cause  of  Discrimination  among 
Places.  §  2.  Economic  Loss  which  May  Flow  from  Dis¬ 
crimination  among  Places.  §  3.  The  Uneconomy  of 
Discrimination  either  in  Favor  of  or  against  Imports. 

§  4.  The  Uneconomy  of  the  “  Basing-point  ”  System. 

§  5.  Discrimination  in  Favor  of  Intrastate  Business,  Re¬ 
sulting  from  Orders  of  State  Commissions.  §  6.  Dis¬ 
crimination  by  a  Transportation  Company  in  Favor  of 
Traffic  Moving  a  Long  Distance  over  its  Own  Lines. 

§  7.  Summary. 


CHAPTER  V 

Economically  Defensible  Discrimination  among  Places  120-159 

§  1.  Discrimination  among  Places,  by  a  Roundabout 
Line.  §  2.  Discrimination  by  the  Longer  or  Longest 
Line,  when  there  is  Competition  of  Directions  or  of  Lo¬ 
cations.  §  3.  Discrimination  by  the  Shorter  or  Shortest 
Line,  when  Such  a  Line  has  Comparatively  Light  Traffic. 

§  4.  Discrimination  among  Places,  by  a  Railroad  Com¬ 
peting  with  a  Water  Line.  §  5.  Discrimination  among 
Places,  by  a  Railroad  Competing  with  Local  Self- 
sufficiency.  §  6.  Discrimination  in  Favor  of  Export 
Traffic.  §  7.  Discrimination  between  Directions. 

§  8.  Summary. 


CHAPTER  VI 

Relative  Rates  on  Different  Goods  ....  160-174 

§  1.  Why  Rates  on  Competing  Goods  should  be  in 
Proportion  to  Transportation  Cost.  §  2.  The  Proper 
Relation  of  Rates  on  Finished  Products  to  Rates  on  Raw 
Materials.  §  3.  When  Rates  may  Properly  be  Lower  on 
Some  Kinds  of  Goods  than  on  Others,  in  Relation  to 
Cost  of  Carriage.  §  4.  Summary. 


CONTENTS  BY  SECTIONS  xxiii 

CHAPTER  VII 

PAGES 

Discrimination  among  Shippers . 175-192 

§  1.  Methods  of  Practicing  and  of  Concealing  Dis¬ 
crimination  among  Shippers.  §  2.  Competition  of 
Transportation  Lines  as  Causing  this  Discrimination. 

§  3.  Other  Causes  of  Discrimination  among  Shippers. 

§  4.  The  Practice  of  Discriminating  among  Shippers, 

Tested  by  the  Principles  of  Industrial  and  Commercial 
Ethics.  §  5.  Summary. 


PART  I 


THE  EXCHANGE  MECHANISM  OF  COMMERCE 


I 


PRINCIPLES  OF  COMMERCE 

CHAPTER  I 
Laws  of  Money 
§  i 

Quantitative  Statement  of  the  Relation  between  Money  and 

Prices 

Primitive  trade  is  often  a  direct  trading  of  one  kind 
of  goods  for  another,  the  process  called  barter.  The 
exchange  of  knives,  hatchets,  guns,  mirrors,  etc.,  with 
the  Indians,  in  return  for  land  and  furs,  with  which  we 
have  been  made  familiar  in  our  school  histories  and  in 
stories  of  adventure,  was  trade  of  this  sort.  But  even 
the  Indians  had  wampum,  which  they  used  as  a  medium 
of  exchange,  and  the  highly  civilized  countries  have 
long  since  made  use  of  money,  whether  of  gold  or  silver 
or  other  material,  in  their  commerce.  A  study  of  the 
laws  of  commerce  involves,  then,  and  may  well  involve 
as  a  preliminary  step,  a  study  of  the  laws  of  money. 
We  are  not  likely  to  find  that  the  basic  principles  of  trade 
are  so  very  different  with  money  used  than  they  would  be 
if  the  world  traded,  supposing  it  conveniently  could, 
goods  of  one  kind  directly  for  goods  of  another.  The 


B 


I 


2  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


money-using  method  of  trade  is  more  efficient.  The 
motives  for  trade  and  the  nature  of  the  advantages  from 
it  are  the  same  whether  money  is  used  or  not.  But  it 
is  worth  while  analyzing  the  commercial  processes,  as 
they  are  actually  carried  on,  even  in  many  of  their  mod¬ 
ern  complications.  To  do  so,  may  perhaps  the  more 
clearly  expose  fallacies  regarding  trade,  not  uncommonly 
held.  We  shall  begin,  then,  with  a  study  of  money, 
considered  as  an  important  part  of  the  mechanism  of 
trade. 

Money,  as  a  medium  of  exchange,  is  a  kind  of  wealth 
or  property  for  which  other  goods  are  sold  and  with 
which,  in  turn,  desired  goods  are  bought.  It  may  be 
distinguished  from  other  wealth  or  property  by  its 
characteristic  of  general  exchangeability.  A  person 
desiring,  as  all  do  desire  who  are  engaged  in  any  business 
or  regular  occupation  or  who  have  capital  to  invest,  to 
dispose  of  some  kinds  of  goods  or  services  in  exchange 
for  others,  does  not  need  to  seek  out  those  who  both  want 
what  he  has  to  sell  and  will  sell  what  he  wants  to  buy  and 
with  whom  he  can  make  a  satisfactory  trade  “in  kind.” 
Instead,  he  sells  for  money,  for  a  universally  desired 
medium,  what  he  has  to  dispose  of,  to  whoever  desires 
it,  and,  with  this  money  as  purchasing  power,  seeks  out 
those  who  have  for  sale  what  he  himself  wishes  to  buy. 
The  use  of  money  is  an  intermediate  step  in  what  is  still 
the  exchange  of  goods  for  goods.  In  order  that  money 
may  perform  its  function  of  facilitating  trade,  both  goods 
to  be  sold  and  goods  to  be  bought  must  be  valued  in 
terms  of  money.  Money  becomes  a  measure  of  value 
as  well  as  a  medium  of  exchange.  One  kind  of  goods 
will  have  a  higher  value,  measured  in  money,  than  an¬ 
other  kind,  if  its  cost  of  production  is  greater,  or  if,  for 


LAWS  OF  MONEY 


3 


any  other  reason,  only  the  higher  value  will  equalize 
supply  of  and  demand  for  this  kind  of  goods.  The  same 
relation  of  values,  between  two  sorts  of  goods,  would 
exist  if  money  were  not  used,  but  the  use  of  money  makes 
it  measurable  in  a  generally  familiar  standard. 

An  analysis  of  the  prices  or  values  of  one  sort  of  goods 
as  compared  with  those  of  other  sorts,  leads  us  to  a  con¬ 
sideration  of  the  special  forces  of  demand  and  supply, 
such  as  utility  and  cost  of  production,  acting  upon  such 
goods.  In  studying  the  laws  of  money  we  need  to  attend 
not  so  much  to  the  conditions  determining  the  value  of 
one  kind  of  goods  in  relation  to  some  other  kind  or  kinds, 
as  to  the  conditions  determining  the  average  value  of 
goods  in  relation  to  money,  and  vice  versa.  We  have  to 
consider,  that  is,  the  general  level  of  prices,  and  conversely 
the  purchasing  power  of  money. 

This  relation  between  money  and  other  goods  has  sev¬ 
eral  times  been  given  a  mathematical  form  of  statement.1 
Let  S  represent  the  total  amount  of  money  (number  of 
dollars)  spent  in  a  given  community  during  a  given 
period  of  time,  say  a  year.  Let  M  represent  the  (average) 
number  of  dollars  in  that  community  during  the  same 
period.  Then  the  average  number  of  times  a  dollar  is 
spent  during  the  year  will  be  S/M.  This  is  the  velocity 
of  circulation  of  money  and  may  be  called  V . 
S  =  MS/M ,  and  therefore,  by  the  method  of  substi¬ 
tution,  S  =  MV.  In  words,  the  total  dollars  spent  for 
goods  is  equal  to  the  number  of  dollars  in  the  community 
times  the  average  velocity  of  circulation  of  those  dollars. 

But  the  total  number  of  dollars  spent  for  goods  is  also 

1  For  instance,  Newcomb,  Principles  of  Political  Economy,  New  York  (Har¬ 
per),  1885,  p.  346;  Edgeworth,  "Report  on  Monetary  Standard,”  Report  of  the 
British  Association  for  the  Advancement  of  Science,  1887,  p.  293;  Hadley, 
Economics,  New  York  (Putnam),  1906,  p.  197. 


4  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


equal  to  the  sum  of  the  quantities  of  all  the  kinds  of 
goods  bought,  times  their  respective  prices.  Let  the 
price  per  pound  and  the  number  of  pounds  of  sugar 
bought  be  represented  respectively  by  p  and  q ,  the  price 
per  bushel  of  wheat  and  the  number  of  bushels  bought 
by  p'  and  q' ,  and  so  on.  Then  the  total  number  of 
dollars  spent  for  goods,  i.e.  S ,  is  equal  to  pq  -j-  p'q'  +  etc. 
Since  two  things  equal  to  the  same  thing  are  equal  to 
each  other,  and  since 

S  =  MV  and  also 

S  =  pq  +  p'q'  +  etc., 

therefore 

MV  =  pq  +  p'q'  +  etc. 

This  is  the  mathematical  statement  of  the  so-called 
quantity  theory  of  money,  omitting,  however,  any 
reference  to  credit  currency.1  It  asserts  simply  that  the 
quantity  of  money  times  its  velocity  of  circulation,  equals 
the  prices  of  goods  bought  with  money,  times  the  quan¬ 
tities  bought.  The  conclusion  follows,  therefore,  that 
if  the  quantity  of  money,  M ,  increases,  while  the  velocity 
of  circulation  and  the  volume  of  trade  remain  the  same, 
prices  will  rise  in  the  same  proportion.  A  decrease  in 
the  amount  of  M  would,  on  the  same  assumption,  be 
accompanied  or  followed  by  a  fall  in  the  money  prices 
of  goods.  An  increase  in  the  q’s  2  or  volume  of  trade 
would,  other  things  equal,  occasion  a  fall  of  prices ;  and  a 
decrease  in  the  q’s,  a  rise  of  prices. 


1  For  consideration  of  credit,  see  Chs.  II  and  III  (of  Part  I). 

2  The  q’s  or  quantities  of  goods  should  be  held  to  include  not  only  finished 
goods  exchanged  in  trade  and  goods  purchased  for  raw  material,  but  also  the 
additions  made  by  labor  to  the  utility  of  goods  and  paid  for  in  wages  and  the 
additions  made  by  the  service  of  “waiting”  and  paid  for  by  means  of  interest, 
dividends,  etc. 


LAWS  OF  MONEY 


S 


Causal  Explanation  of  the  Price  oj  a  Given  Kind  of  Goods 

A  quantitative  or  mathematical  statement  of  a  prin¬ 
ciple  is  not,  however,  an  adequate  explanation  of  that 
principle.  In  this  case,  the  explanation  must  be  found 
in  the  working  of  the  market,  in  competition  with  each 
other  of  buyers  and  of  sellers.  This  means  that  there 
must  be  an  analysis  of  the  forces  of  supply  and  demand  in 
relation  to  general  or  average  prices,  in  addition  to  the 
usual  study  of  those  forces  in  relation  to  particular 
prices. 

The  price  of  any  particular  kind  of  goods,  say  the 
price  of  wheat  per  bushel,  is  commonly  said  to  be  fixed 
by  the  equation  of  supply  and  demand.  But  these 
terms  are  frequently  misunderstood.  For  example, 
supply  is  sometimes  thought  of  as  the  total  stock. 
Demand  is  thought  of  as  the  amount  wanted  by  pur¬ 
chasers,  but  without  much  reference  to  the  exact  condi¬ 
tions  determining  this  amount.  As  a  matter  of  fact, 
supply  is  not  the  total  stock  of  a  good,  whatever  relation 
it  may  have  to  this  stock.  Supply  is  different  according 
as  price  is  different.  Hence  any  reference  to  supply 
should  specify  a  price.  The  supply  of  any  good  at  a 
given  price  is  the  amount  which  sellers  are  ready  to 
dispose  of  at  that  price.1  Thus,  the  supply  of  wheat 
at  a  price  of  $1.10  per  bushel  may  be,  in  a  given  market, 
i  ,000,000  bushels.  That  is,  at  a  price  of  $i . io  per  bushel, 
there  are  so  many  persons  ready  to  sell  wheat  and  ready 
to  sell  such  quantities,  that  1,000,000  bushels  may  be  had. 

1  See  J.  S.  Mill,  Principles  of  Political  Economy,  Book  III,  Ch.  II,  §  4. 
One  of  the  best  recent  presentations  of  the  theory  of  supply  and  demand  is  to 
be  found  in  Fisher,  Elementary  Principles  of  Economics,  New  York  (Macmillan), 

1912,  Ch.  XV. 


6  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


In  general,  the  higher  the  price,  the  larger,  other  things 
equal,  will  be  the  supply ;  and,  similarly,  the  lower  the 
price,  the  smaller  will  be  the  supply.  If  the  price  of  any 
good  is  lower  relatively  to  other  desired  goods,  producers 
and  sellers  will  be  less  inclined  to  bring  the  good  to  market 
for  disposal,  and  may  even  turn  their  attention  to  other 
lines.  If  the  price  is  higher,  they  will  be  more  inclined 
to  sell  large  quantities,  and  some  may  be  tempted  to 
forsake  other  lines  to  produce  the  good  in  question. 

In  the  same  way,  reference  to  demand  should  specify 
a  price.  Analogously,  the  demand  for  any  good  at  a 
given  price  is  the  amount  that  purchasers  stand  ready  to 
take  at  that  price.  If  at  $1.10  per  bushel  the  demand  for 
wheat  is  for  1,000,000  bushels,  then  the  number  of  per¬ 
sons  wishing  to  buy  wheat  is  such,  and  the  amounts  they 
individually  stand  ready  to  buy  are  such,  as  to  make 
an  aggregate  of  1,000,000  bushels.  Other  things  equal, 
demand  rises  as  price  falls,  and  falls  as  price  rises.  The 
lower  the  price  of  any  good  in  relation  to  prices  of  other 
goods,  the  more  ready  are  purchasers  to  buy  it ;  and  the 
higher  the  price,  the  less  ready.  The  price  of  any  good, 
whether  of  cotton,  labor  services,  bills  of  exchange  or 
anything  else  marketable,  is  fixed  where  supply  and 
demand  are  equal. 

It  is  not,  however,  an  explanation  of  price  merely  to 
state  that  it  is  fixed  where  supply  and  demand  are  equal. 
It  is  necessary  further  to  inquire  why  price  is  fixed  at  that 
point.  If  supply  of  and  demand  for  wheat  in  a  given 
market  are  equalized  at  $1.10  per  bushel,  why  may  not 
the  price  nevertheless  be  $1  ?  If  we  assume  $1  to  be  the 
price,  we  see  that  such  a  price  represents  a  position  of 
unstable  equilibrium.  At  this  price,  the  demand  would 
be  in  excess  of  the  supply.  The  persons  anxious  to  buy 


LAWS  OF  MONEY 


7 


wheat  are  ready  to  buy,  at  this  price,  more  than  can  be 
had,  and  since  even  at  $1.10  the  amounts  they  will  buy 
are  equal  to  the  amounts  they  can  get,  it  appears  that 
there  are  many  who  would  gladly  pay  more  than  $i  per 
bushel  rather  than  go  without  wheat  entirely.  Here, 
then,  are  persons,  many  of  whom  would  pay  more  rather 
than  not  get  the  wheat,  the  aggregate  of  whose  desired 
purchases  at  $i  per  bushel  must  exceed  the  total  supply 
offered.  If  $i  is  the  price,  some  who  would  gladly  pay 
that  and  more  cannot  get  the  wheat  they  desire.1  Each 
intending  purchaser  will  fear  that  he  will  be  one  of  those 
who  fail  to  get  what  they  wish.  Since  all  cannot  be 
satisfied  and  since  he  himself  may  not  be,  he  is  likely  to 
offer  more  than  $i  in  the  hope  that  sellers  will  be  per¬ 
suaded  to  sell  to  him,  at  least.  But  he  is  not  likely  to 
offer  more  than  $1.10.  According  to  our  hypothesis, 
a  price  of  $1.10  will  bring  forth  a  supply  fully  equal  to 
the  demand.  Even  if  other  buyers  are  foolish  enough  to 
offer  a  higher  price  and  are  sold  to  in  preference,  yet  since 
the  demand  of  these  others  would  not  absorb  the  entire 
supply,  a  purchaser  who  offered  $1.10  would  secure  the 
wheat  desired. 

As  the  price  is  kept  from  going  below  that  height  which 
equalizes  supply  and  demand,  by  the  competition  of 
buyers,  so,  by  the  competition  of  sellers,  it  is  kept  from 
going  above  that  height.  If  $1.10  a  bushel  is  the  equal¬ 
izing  price,  the  competition  of  sellers  will  prevent  the 
price  from  being  higher,  say  $1.15.  For  at  $1.15  there 
would  presumably  be  a  smaller  demand  and  a  greater 
supply.  That  is,  at  $1.15  there  would  be  sellers  anxious 
to  dispose  of,  in  the  aggregate,  more  wheat  than  buyers 

1  This  explanation  of  the  nature  of  competition  is  well  set  forth  in  Hadley, 
Economics,  pp.  75-77. 


8  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


would  take.  Some  of  these  prospective  sellers  must  be 
doomed  to  disappointment,  and  those  most  anxious  to 
sell  would  therefore  bid  against  each  other  in  lowering  the 
price  to  the  point  where  supply  and  demand  were  equal. 
This  they  would  do  because  in  no  other  way  could  they 
be  sure  of  selling  their  wheat.  But  they  need  not  go 
below  the  equalizing  price,  because  when  that  price  is 
reached  there  are  enough  more  buyers  or  enough  fewer 
sellers,  or  both,  to  insure  sales  by  those  still  in  the  market 
and  desiring  to  sell.  Even  if  some  should  offer,  unwisely, 
to  sell  at  a  lower  price,  yet  since  these  could  not,  by  our 
hypothesis,  satisfy  the  demand,  all  who  charged  the 
equalizing  price  would  still  find  purchasers.  The  market 
price  of  any  kind  of  goods,  therefore,  tends  to  be  that 


price  which  equalizes  supply  and  demand,  and  is  pre¬ 
vented  by  the  forces  of  competition  from  going  above  or 

-fc-- 

it. 


Causal  Explanation  oj  the  General  Level  of  Prices 


Let  us  now  apply  the  principles  of  supply  and  demand 
to  the  general  level  of  prices.  We  shall  see  that  much  the 
same  kinds  of  competitive  forces  which  fix  any  one  price 
(as  above  explained)  in  relation  to  other  prices,  fix  the 
general  level  of  prices  of  goods  in  terms  of  money.  We 
shall  consider,  first,  the  supply  of  goods,  including  the 
services  of  labor  and  of  “waiting”  (i.e.  investing,  or 
putting  capital  into  use,  the  service  for  which  interest  is 
paid)  offered  for  money,  and  the  demand  for  goods  by 
those  having  money  to  spend.  Afterwards  we  can  reverse 
our  method  and  consider  the  supply  of  and  the  demand 
for  money  in  exchange  for  other  goods. 

Where  there  is  only  fiat  (inconvertible  paper)  money, 


LAWS  OF  MONEY 


9 


the  supply  of  goods  in  general,  offered  for  money,  at  any 
level  of  average  prices  of  those  goods,  would  be  just  the 
same  as  at  any  other  level  of  prices.  This  is  very  nearly 
true  no  matter  what  the  money  system.1  If  wheat  prices 
are  higher  than  corn  prices,  or  vice  versa,  productive 
effort  may  be  diverted  from  one  line  into  another.  But 
we  are  now  not  discussing  changes  in  individual  or  rela¬ 
tive  prices.  We  are  discussing  only  changes  in  the 
general  level  of  prices,  the  average  of  prices.  If  the  gen¬ 
eral  level  of  prices  should  double,  there  is  no  reason  to 
believe  that  the  amount  of  goods  produced  for  sale  would 
on  that  account  greatly  increase.  Supposing  a  com¬ 
munity  to  be  in  reasonable  prosperity  and  business 
activity  at  the  lower  prices,  an  increase  of  these  prices 
would  not  make  possible  a  very  greatly  increased  pro¬ 
duction.  It  would  not  enable  men  to  work  longer  hours 
nor  would  it  make  machinery  more  efficient.  Neither 
would  it  stimulate  the  sales  of  goods  by  making  such  sales 
more  profitable,  since  a  general  rise  of  prices  simply 
means  that  money  has  a  less  value.  If  everything  should 
sell  for  twice  as  much  money  as  before,  the  sellers  would 
gain  nothing,  for  the  things  they  desired  to  buy  would 
also  cost  twice  as  much.  Looking  at  the  matter  from 
any  reasonable  point  of  view,  it  must  be  admitted  that 
the  supply  of  goods  in  general,  at  a  higher  level  of  prices, 
would  be  no  greater  (or  but  slightly  greater) 2  than  at  a 
lower  level.  Likewise,  at  a  lower  level  of  prices,  the 
supply  of  goods  would  be  no  less  than  at  a  higher  one. 
A  lower  level  of  prices  would  not  mean  less  activity  or  a 
smaller  sale  of  goods.  It  would  pay  as  well  to  sell  goods 
at  a  low  level  of  prices  as  at  a  high  level,  since  at  the  lower 

1  See  remainder  of  this  section  for  explanation  of  why  it  is  not  always  entirely 
true. 

1  See  next  paragraph. 


10  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


level  the  money  received  would  have  correspondingly 
greater  purchasing  power. 

The  lower  level  of  prices  would  only  decrease  the 
supply  of  other  goods  and  the  higher  level  increase  it,  in 
one  contingency,  and  then  only  to  a  very  limited  degree. 
When  the  currency  system  is  based  on  a  precious  metal, 
e.g.  gold,  a  lower  level  of  prices  means  a  higher  value 
of  gold  as  money.  It  might  therefore  divert  some  labor 
from  the  production  of  other  goods  to  the  production  of 
gold  for  coinage.  A  higher  level  of  prices  might  tend, 
in  the  same  degree,  to  divert  labor  from  gold  production 
towards  the  production  of  other  goods.  To  this  extent 
only,  a  higher  level  of  prices  would  tend  to  increase  the 
supply  of  goods  in  general  other  than  money,  and  a  lower 
level  of  prices  to  decrease  it. 

On  the  other  hand,  a  higher  level  of  prices  of  goods 
would  tend  to  decrease  the  demand  for  goods  by  persons 
having  money  to  spend.  For  with  higher  prices,  and  no 
greater  amount  of  money  to  spend,  buyers  of  goods  would 
be  unable  to  purchase  as  much  as  at  lower  prices.  Lower 
prices  of  goods  would  mean  that  the  money  of  purchasers 
would  go  farther. 

Let  us  now  suppose  a  doubling  of  the  amount  of  money. 
Prices  would  tend  to  increase  in  nearly  the  same  pro¬ 
portion.  Suppose  prices  did  not  rise.  Then  purchasers 
of  goods  would  buy  all  they  were  in  the  habit  of  buying 
and  still  have  as  much  money  left  to  spend  as  they 
formerly  spent  all  together.  This  they  would  endeavor 
to  spend  at  once.  For  in  modern  countries  money  is  not 
hoarded  away,  but  only  enough  is  kept  on  hand  for 
emergency  requirements,  and  the  rest  is  spent.  Those 
who  save  are  spending  just  as  effectually  as  any  others. 
The  difference  is  in  what  they  buy.  Those  who  save, 


LAWS  OF  MONEY 


ii 


buy  factories,  warehouses,  railroads,  farms,  etc.  Even 
though  their  savings  are  put  into  a  savings  bank,  they  are 
none  the  less  spent  for  investment  goods.  It  follows 
that  a  sudden  doubling  of  the  amount  of  money,  if  prices 
did  not  increase,  would  mean  a  demand  for  goods  far 
exceeding  the  supply.  The  amount  of  land  is  practically 
constant.  Doubling  the  amount  of  money  would  not 
enable  people  to  work  longer  hours  and  so  increase  the 
products  of  labor.  In  a  busy  community  the  supply  of 
goods  to  be  sold  simply  could  not  be  doubled  except 
with  an  increase  of  population  or  invention.  The  in¬ 
creased  money  would  therefore  mean  that  at  the  old 
prices  the  demand  for  goods  in  general  would  exceed  the 
supply.  Purchasers  would  bid  against  each  other. 
Prices  would  rise.  Equilibrium  would  only  be  reached, 
supply  and  demand  be  equal,  at  a  general  level  of  prices 
nearly  (or,  if  fiat  money,  quite)  twice  that  which  had 
preceded. 

If  prices  rose  equally,  this  would  mean  a  doubling  in 
the  money  wages  of  labor  for  the  same  results  produced 
and,  similarly,  a  doubling  in  the  money  interest,  dividends 
or  profits  received  for  “waiting.”  Aside  from  disturb¬ 
ing  effects  during  the  period  of  transition,  the  rate  of 
interest  would  be  the  same  with  the  high  prices  as  with 
the  low.  The  money  value  of  the  sum  waited  for  would 
be  doubled  and  the  money  value  of  the  interest  would  be 
doubled.  The  ratio  between  them  would  be  the  same 
as  before.  In  other  words,  since  prices  have  doubled, 
borrowers,  for  example,  would  require  twice  as  many 
dollars  as  before  and  would  also,  of  course,  pay  twice  as 
many  dollars  in  interest. 

In  the  light  of  the  principles  above  set  forth,  regarding 
supply  and  demand,  we  can  explain  why  the  excessive 


12  THE  EXCHANGE  MECHANISM  OF  COMMERCE 

amounts  of  inconvertible  paper  money  sometimes  issued 
by  governments,  issued  particularly  in  time  of  war,  have 
resulted  in  very  exceptional  rises  in  the  price  level. 
This  increased  amount  of  money  means,  at  any  level  of 
prices,  a  greater  demand  for  goods.  Therefore,  that  the 
demand  for  goods  may  not  exceed  the  supply,  the  level 
of  prices  must  rise.  There  is  another  factor  of  impor¬ 
tance  at  such  times,  viz.  public  confidence  in  the  money 
issued.  If  there  is  a  general  belief  that  the  money  will 
become  absolutely  valueless  or  greatly  decrease  in  value, 
then  many  who  have  goods  to  sell  will  refuse  to  sell  them 
for  this  money,  but  will  demand  gold  or  silver  or  other 
goods  in  exchange.  This  decrease  in  the  supply  of  goods, 
offered  for  money,  will  mean  that  only  a  higher  level  of 
prices  than  otherwise  would  result  can  equalize  supply 
and  demand.  Thus  is  to  be  explained  the  high  prices 
(and,  reciprocally,  the  great  depreciation  of  money)  in 
such  periods  as  the  American  Revolution,  the  Civil  War, 
etc. 

§4 

Causal  Explanation  of  the  Value  oy  PuYchasing  PoweY  of 

Money ,  the  RecipYocal  of  the  Level  of  PYices  of  Goods 

Let  us  look  at  the  same  problem,  the  general  level  of 
prices,  from  the  other  side,  that  of  the  purchasing  power 
of  money  or  the  value  of  money  in  terms  of  goods.  We 
shall  consider  now  the  supply  of  money  offered  by 
purchasers  of  goods  (corresponding  to  demand  for  goods) 
and  the  demand  for  money  coming  from  sellers  of  goods 
(corresponding  to  the  supply  of  these  goods). 

Before  defining  supply  of  and  demand  for  money,  we 
must  select  a  phrase  to  express  the  price  of  money.  The 
value  or  price  of  money  is  usually  expressed,  not  in  terms 


LAWS  OF  MONEY 


13 


of  any  one  thing,  but  in  terms  of  all,  or  most  other, 
purchasable  goods.  Its  value  or  its  price  is  measured  in 
the  amount  of  other  goods  it  can  buy.  The  value  or 
price  of  money  we  shall  therefore  call  the  purchasing 
power  of  money. 

We  may  now  define  money  supply  and  demand  con¬ 
sistently  with  wheat  or  coal  supply  and  demand.  First, 
as  to  supply,  we  may  say  that  the  supply  of  money  at  any 
given  purchasing  power  is  the  amount  of  money  which 
would  he  supplied  —  i.e.  would  be  offered  in  purchase  of 
goods  —  at  that  purchasing  power.  Just  as,  at  a  higher 
price  of  wheat,  the  supply  in  the  long  run  would  tend  to 
be  greater  than  at  a  lower  price,  so,  at  a  higher  purchas¬ 
ing  power  of  money,  the  supply  of  money  would  tend  to 
be  greater  than  at  a  lower  purchasing  power.  The  supply 
would  be  greater  at  a  higher  purchasing  power,  because, 
at  a  higher  purchasing  power,  it  would  be  worth  while  to 
turn  bullion  into  coins  or  even  to  mine  more  gold  for  that 
purpose.  The  supply  of  fiat  money  (irredeemable 
paper)  would  not  be  greater,  but  would  be  just  the  same 
at  a  higher  purchasing  power  as  at  a  lower.  The  normal 
supply  of  money  at  any  purchasing  power  and  during 
any  period  of  time,  the  amount  that  would  be  offered  by 
sellers  of  money  (i.e.  buyers  of  goods)  involves,  as  Walker 
has  pointed  out,1  the  quantity  of  money  and  its  rapidity 
or  velocity  of  circulation.  This  velocity  of  circulation 
may  be  less  than  unity ;  that  is,  most  of  the  money  may 
circulate  less  than  once  if  we  are  dealing  with  an  instant 
or  a  short  period  of  time.  But  if  we  are  dealing  with  a 
long  period  of  time,  say  a  year,  and  with  the  conditions 
determining  normal  purchasing  power,  the  velocity  will 

1  Political  Economy,  Advanced  Course,  third  edition,  New  York  (Holt)  1887, 
p.  129. 


14  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


perhaps  be  20  or  more.1  In  any  case,  the  supply,  the 
amount  that  would  be  offered  at  any  given  purchasing 
power,  is  the  total  amount  which,  at  that  purchasing 
power,  would  be  on  hand,  multiplied  by  its  velocity; 
and  it  may  be  represented,  therefore,  as  MV. 

Turning  to  the  subject  of  demand,  we  may  properly 
define  the  demand  for  money,  at  any  purchasing  power, 
as  the  amount  of  money  that  would  be  taken  by  sellers 
of  goods,  at  that  purchasing  power.  The  demand  for 
money  comes  from  the  sellers  of  other  goods  who  wish 
to  take  money  in  exchange  for  those  goods.  They  may  be 
said  to  buy  money  with  the  goods  they  sell.  When  the 
money  is  altogether  fiat  (inconvertible  paper)  money, 
the  amount  of  goods  offered  for  money  will  not  be  affected 
by  the  purchasing  power  of  money.  With  an  exception 
shortly  to  be  noted,  this  is  also  true  in  the  case  of  such  a 
commodity  money  as  gold  or  silver.  That  the  purchas¬ 
ing  power  is  at  any  time  greater  or  less,  provided  only  it  is 
not  fluctuating,  affects  neither  for  good  nor  ill  the  sellers 
of  goods.  If  the  purchasing  power  of  money  is  greater, 
they  will  still  sell  their  goods  as  readily  for  money  since 
the  smaller  amount  of  money  so  received  will  go  as  far 
as  would  a  larger  amount  having  a  smaller  purchasing 
power  per  unit  ( e.g .  per  dollar).  But  their  demand  for 
money,  in  the  proper  use  of  the  term  “demand,”  will 
not  be  the  same.  If  the  purchasing  power  of  money  is 
doubled,  demand  for  money  will  be  exactly  halved.  If 
the  purchasing  power  of  money  is  halved,  demand  for 
money  will  be  doubled.  Sellers  of  goods  will  take  all  the 
money  which  the  goods  they  desire  to  sell  will  bring. 
If,  therefore,  the  purchasing  power  of  money  is  halved, 

1  See  Fisher,  The  Purchasing  Power  of  Money,  New  York  (Macmillan),  1911, 
p.  290. 


LAWS  OF  MONEY 


i5 


i.e.  if  it  takes  twice  the  former  amount  of  money  to  buy 
the  same  goods,  then  the  demand  for  money,  the  amount 
sellers  of  goods  (buyers  of  money)  will  take,  at  this  pur¬ 
chasing  power,  will  be  exactly  doubled.1 

The  exception  to  be  noted  has  already  been  referred 
to  in  the  discussion  of  the  general  level  of  prices.2  It  oc¬ 
curs  when  money  is  based  on  some  standard  commodity, 
as  gold,  having  an  appreciable  cost  of  production.  To 
double  the  purchasing  power  of  money  would,  in  fact, 
probably  reduce  the  demand  for  it  to  something  very 
slightly  less  than  half  what  it  had  been,  for  a  small  (rela¬ 
tively  a  very  small)  amount  of  labor  would  probably  be 
diverted  from  the  production  of  other  goods  to  the  mining 
of  gold.  Therefore,  unless  the  value  of  money  more  than 
doubled  (i.e.  unless  money  prices  of  goods  became  less  than 
half),  the  money  which  would  be  taken  by  sellers  of  the 
somewhat  smaller  stock  of  goods  would  be  less  than  half 
as  great.  Similarly,  a  fall  of  half  in  the  value  of  money 
would  very  probably  divert  some  labor  from  gold  mining 
into  other  lines,  and  so  might  slightly  more  than  double 
the  demand  for  money.  For  every  one  would  be  ready 
to  sell  his  goods  at  twice  the  former  price,  and  there  would 
be  more  goods  to  sell.  Normal  demand,  therefore,  for 
money,  i.e.  long-run  demand,  cannot  be  distinguished  by 
any  exact  proportion  from  demand  for  other  goods. 
But  when  the  money  does  not  involve  an  appreciable  cost 
of  production,  but  is  inconvertible  paper,  or,  for  any 
money,  where  an  extremely  short  period  is  involved,  the 
demand  for  money  varies  inversely  with  its  purchasing 
power. 


1  Were  it  not  for  the  exception  next  to  be  mentioned,  the  demand  curve  for 
money  would  be  always  a  rectangular  hyperbola. 

*  §  3  of  this  chapter  (I  of  Part  I). 


16  THE  EXCHANGE  MECHANISM  OF  COMMERCE 

I 

The  demand  for  money  by  sellers  of  goods  may  be  said 
to  be  the  money  value  at  which  they  would  sell  those 
goods ;  therefore,  the  prices  times  the  quantities ;  there¬ 
fore,  pq  +  p'q'  +  etc.  The  purchasing  power  of  money 
is  fixed  where  supply  is  equal  to  demand,  where 
MV  =  pq  -f  p'q'  -f-  etc.  The  equation  of  exchange  may 
be  regarded  as  simply  a  mathematical  mode  of  stating 
that  the  p’s,  the  purchasing  power  of  money,  must  be 
such  that  supply  of  money  equals  demand,  i.e.  that 
MV  =  pq  +  p'q'  +  etc. 


The  Theory  of  Bimetallism 

The  laws  of  supply  and  demand  serve  to  explain  the 
effects  of  the  various  monetary  systems  which  have  been 
tried  in  different  countries.  Important  among  those 
monetary  systems  is  bimetallism.  Bimetallism  involves 
the  concurrent  circulation  of  two  metals  at  a  fixed  legal 
ratio.  Both  metals  are  coined  by  government,  for  those 
bringing  the  metals  to  the  mints,  in  any  desired  quantity, 
and  coined  without  charge  or  for  the  mere  cost  to  gov¬ 
ernment  of  coining.  Both  metals,  when  so  coined,  are 
legal  tender  for  the  payment  of  debts  and  taxes,  at  the 
value  ratio  fixed.  Thus,  bimetallism  at  16  to  i  meant, 
for  the  United  States,  that  the  amount  of  silver  in  the 
silver  dollar  should  be  approximately  16  times  the  amount 
of  gold  in  a  gold  dollar,  that  gold  and  silver  should  both 
be  coined  freely  and  without  limit,  and  that  a  debtor 
should  be  able  to  liquidate  the  same  debt  with  ioo  silver 
dollars  as  with  ioo  gold  dollars. 

Bimetallism  may  succeed  if  the  legal  ratio  is  not  too  far 
from  the  market  ratio  of  values  existing  when  the  system 


LAWS  OF  MONEY 


x7 


is  started.  If  the  amount  of  silver  in  the  legal  silver  dollar 
is  worth  98  per  cent  as  much  as  the  gold  in  the  gold  dollar, 
or  98  cents,  then  the  system  may  succeed.1  It  will 
succeed  because  the  possibility  of  using  98  cents’  worth  of 
silver,  if  coined,  to  pay  a  $1  debt  (or  tax)  previously 
payable  in  gold,2  will  stimulate  the  coinage  of  silver. 
This  extra  demand  for  silver  will  increase  its  value. 
Otherwise  expressing  the  matter,  we  may  say  that  the 
withdrawal  of  silver  from  the  arts,  tending  to  cause  a  de¬ 
creased  supply  of  silver  for  arts  uses,  will  increase  its  value. 
The  greater  quantity  of  money  will  tend  to  make  some¬ 
what  higher  prices  and  a  somewhat  lower  value  of  a  dollar 
(whether  gold  or  silver) .  This  may  discourage  the  coin¬ 
age  of  gold  or  even  cause  the  melting  of  some  gold  coin 
into  bullion.  We  may  say  that  the  less  demand  for  gold 
has  made  its  value  fall,  or  that  the  melting  of  gold  coin 
and  the  consequent  greater  supply  of  gold  in  the  arts  has 
made  its  value  fall.  The  sequence  is,  then,  flow  of  silver 
from  bullion  into  coin,  slightly  depressed  value  of  coin, 
flow  of  gold  from  coin  into  bullion.  Silver  has  risen  in 
value.  Gold  has  fallen.  Probably  the  silver  dollar  is, 
therefore,  now  worth  the  same  as  the  gold  dollar  instead 
of  98  per  cent  as  much.  If  the  bullion  content  of  the  gold 
dollar  came  to  be  of  the  less  value,  debtors  would  prefer 
to  coin  gold  and  the  flow  would  be  in  the  opposite  direc¬ 
tion,  but  likewise  towards  the  establishment  of  equilib¬ 
rium. 

Suppose,  however,  that  the  amount  of  silver  in  a  silver 
dollar  is  worth  only  40  per  cent  of  the  gold  dollar  (which 
was  more  nearly  the  case  with  the  silver  dollar  when  its 


1  Cf.  Fisher,  Elementary  Principles  of  Economics,  pp.  230,  231. 

2  Or  money,  on  a  parity  with  the  gold,  other  than  silver  money  coined  for 
account  of  the  debtor. 


C 


18  THE  EXCHANCE  MECHANISM  OF  COMMERCE 


free  coinage  was  advocated  in  1896).  Then  the  danger 
would  be  that,  long  before  the  increased  demand  for  silver 
as  money  and  its  decreased  supply  in  the  arts,  coupled 
with  the  decreased  demand  for  gold  as  money  and  its 
increased  supply  in  the  arts,  had  brought  about  the 
desired  equilibrium  of  value,  the  gold  would  be  entirely 
driven  out  and  the  money  used  would  simply  be  silver 
instead  of  gold.  The  whole  question  would  be  whether 
the  scarcity  of  silver  in  the  arts  and  the  plentifulness  of 
gold  in  the  arts  would  be  sufficiently  marked  to  make 
the  relative  values  the  same  as  in  the  legal  ratio,  before 
silver  enough  had  been  taken  from  the  arts  uses  to  fill 
all  the  money  circulation;  and  then,  whether  sufficient 
additional  supplies  of  silver  could  be  got  from  the  mines 
to  drive  out  the  gold  without  forcing  the  margin  of  pro¬ 
duction  unprofitably  low,  i.e.  without  mining,  at  a  loss, 
from  poor  mines. 

For  one  country  alone,  the  prospects  of  success  in  es¬ 
tablishing  bimetallism  would  be  much  less  bright  than 
for  a  group  of  important  commercial  countries.  For  if 
one  country  tried  it  alone,  endeavoring  by  free  coinage 
to  make  40  cents’  worth  of  silver  equal  to  $1  worth  of 
gold,  it  would  have  to  absorb  into  its  currency,  not  only 
silver  from  within  its  own  borders,  but  silver  flowing  to 
it  from  all  the  world,  and  its  own  demand  in  relation  to 
such  a  great  supply  might  increase  the  value  of  silver 
relatively  little.  And,  as  the  silver  drove  out  the  gold, 
the  latter  would  not  fall  rapidly  in  value  through  con¬ 
gesting  the  arts,  but  would  be  distributed  to  the  money 
supplies,  as  well  as  the  arts,  of  all  other  countries. 


LAWS  OF  MONEY 


19 


The  Value  of  Subsidiary  Money 


At  the  present  time,  in  the  United  States,  France,  and 
elsewhere,  there  exists  the  so-called  limping  standard, 
i.e.  there  are  silver  coins  the  bullion  value  of  which  is  not 
equal  to  their  face  value,  but  the  amount  of  which  is 
strictly  limited.  In  the  United  States,  there  are  a  cer¬ 
tain  number  of  silver  dollars  and  silver  certificates.  The 
silver  in  the  silver  dollars  is  worth  perhaps  about  half  of 
their  face  value.  But  they  cannot  drive  out  gold  because 
not  enough  are  coined  to  produce  such  a  result.  Any 
money,  even  paper,  if  put  forth  in  very  limited  quantities 
and  made  legal  tender  for  the  payment  of  debts  and  taxes, 
may  circulate  at  par  with  gold.  The  possibility  of  using 
it  for  debts  and  taxes  creates  a  demand  for  it,  and  others 
will  take  it  because  they  in  turn  can  pass  it  to  those  hav¬ 
ing  such  uses  for  it.  A  general  public  confidence  in  and 
willingness  to  take  it  at  the  legal  value,  is  developed. 
On  the  other  hand,  the  limitation  of  its  quantity  means 
a  limited  supply.  The  demand  for  it  equals  this  supply, 
at  a  value  equal  to  par.  Where  a  limited  amount  of 
money  is  issued  by  coining  metal  of  less  value  than  the 
money,  or  by  printing  paper,  this  is  done  by  government 
exclusively  on  its  own  account.  Otherwise  there  would 
be  special  favor  shown,  at  the  general  expense,  to  those 
persons  for  whom  the  coining  was  done. 

Making  paper  or  other  money  redeemable  in  gold  is 
merely  a  way  of  making  the  forces  of  demand  and  supply 
automatic  in  keeping  up  the  value  of  such  credit  money.1 
If  for  any  reason,  e.g.  overissue  or  lack  of  confidence,  the 
value  of  such  money  sinks  below  the  value  of  the  gold 


1  Cf.  Fisher,  The  Purchasing  Power  of  Money ,  pp.  262-263. 


20  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


in  which  it  is  redeemable,  the  holders  of  the  paper  money 
at  once  present  it  in  large  quantities  for  redemption. 
This  immediately  decreases  the  supply  of  it,  and  thus 
automatically  prevents  its  entire  driving  out  of  gold. 
Prompt  redemption  at  the  same  time  gives  confidence 
and  so  maintains  a  demand  for  it.  But  the  limitation 
of  supply,  automatic  or  otherwise,  is  important,  for  no 
amount  of  confidence  can  prevent  a  fall  in  the  value  of 
money  which  increases  indefinitely  in  quantity.  An 
increase  in  gold  itself  tends  to  raise  prices  and  lower 
the  value  of  gold.  An  increase  of  paper  money  tends 
to  increase  prices  in  paper.  Redeemability  prevents 
prices  in  paper  from  ever  rising  higher  than  prices  in 
terms  of  gold. 

In  the  case  of  paper  money,  the  receiver  is  really  a 
creditor.  He  gets  a  credit  claim,  not  real  wealth.  The 
paper  money  evidences  a  right  based  on  its  general 
acceptability,  or  on  its  redeemability  by  government,  to 
an  amount  of  wealth  or  income  services  equal  to  the 
value  of  the  money.  The  issue  of  paper  money  is  a 
species  of  borrowing  by  government ;  but  no  interest  is 
paid,  because  the  holder,  unlike  the  holder  of  government 
bonds,  has,  if  the  money  is  generally  acceptable,  a  demand 
claim.  He  does  not  need,  therefore,  to  wait  for  his 
desired  goods  any  longer  than  he  wishes  to,  but  can  spend 
the  money  and  get  goods  at  any  time  from  another,  who 
can  do  likewise  with  a  third,  etc.  He  does  not  need,  there¬ 
fore,  to  be  in  the  position  of  a  creditor  longer  than  his 
own  convenience  dictates.  The  general  acceptability 
of  such  money,  if  it  is  generally  acceptable,  makes  the 
holder  willing  to  forego  any  other  interest.1 

The  money  of  the  United  States  includes  gold  and  silver 


1  See  Ch.  II  (of  Part  I),  §§  3,  4. 


LAWS  OF  MONEY 


21 


coins,  gold  certificates,  silver  certificates,  United  States 
notes  (greenbacks),  treasury  notes,  and  subsidiary  coins 
(quarters,  dimes,  etc.).  There  are  also  bank  notes,  but 
these  may  be  better  considered,  along  with  other  bank 
credit,  in  the  next  chapter.  All  the  paper  money  except 
silver  certificates  is  redeemable  by  law  in  gold.  Silver 
certificates  are  redeemable  in  silver.  No  law  expressly 
makes  the  silver  dollars  redeemable  in  gold ;  but  it  is 
the  duty  of  the  Secretary  of  the  Treasury  to  maintain  the 
parity  of  the  silver  coinage  with  gold,  and  in  practice  any 
kind  of  our  money  is  exchangeable  at  the  United  States 
Treasury  for  any  other  kind.  Even  without  this  prac¬ 
tice,  the  limitation  on  the  number  of  silver  dollars  and 
their  full  legal  tender  quality  would  doubtless  maintain 
them  at  par  value,  although  the  value  of  the  contained 
bullion  is  much  less. 

§  7 


The  Value  of  Money  as  Related  to  the  Value  of  a  Standard 

Money  Metal 


Most  countries  have  now  the  gold  standard.  All 
money  is  redeemable  in  or  in  some  way  related  to  gold, 
and  the  value  of  money  tends  to  equal  the  value  of  the 
mint  equivalent  in  gold.  So  long  as  gold  is  coined  freely, 
and  in  any  quantity  desired,  into  money,  the  value  of 
gold  as  money  and  as  bullion  must  be  the  same.  For 
if  gold  coin  came  to  have  more  value  than  gold  bullion 
to  be  used  in  the  arts,  then  persons  having  gold  bullion 
would  hasten  to  get  it  coined.  The  consequent  increase 
of  money  would  raise  the  prices  of  goods  and  lower  the 
value  of  money.  The  decrease  of  gold  for  use  in  the  arts 
would  increase  its  value  in  that  use.  Equal  value  in  the 
two  uses  must  soon  be  reached.  If,  on  the  other  hand, 


22  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


gold  as  money  should  have,  at  any  time,  a  less  value  than 
the  same  amount  of  gold  as  bullion,  then  all  newly  mined 
gold  would  be  used  in  the  arts  and  little  or  none  coined, 
until  gold  in  the  arts  was  so  plentiful  and  money  so  scarce 
as  to  make  the  values  even  again.  Gold  money,  if  full 
weight,  might  even  be  melted  into  bullion,  if  it  were 
worth  enough  more  in  the  latter  use  to  pay  for  the 
trouble. 

Eventually,  then,  since,  when  the  gold  standard  is  in 
force,  the  value  of  money  and  the  value  of  gold  bullion 
tend  to  be  the  same,  both  depend  upon  the  amount  of 
gold  mined  relative  to  the  use  for  it.  The  cost  of  pro¬ 
duction  of  gold,  and,  therefore,  the  number  and  richness 
of  gold  mines,  is  not  without  an  influence,  in  the  last 
analysis,  on  the  level  of  prices,  and  on  its  reciprocal, 
the  purchasing  power  of  money.1 

§8 

The  Level  of  Prices  and  the  Value  of  Money  in  One 

Country  or  Locality  as  Related  to  the  Level  of  Prices 

and  the  Value  of  Money  in  Another 

Before  concluding  this  chapter,  something  should  be 
said  regarding  the  relation  of  the  quantity  of  money  and 
prices  in  one  locality  or  country  to  the  quantity  of  money 
and  prices  in  others.2  The  subsidiary  and  credit  money 
of  one  country  is  commonly  not  received  in  other  countries. 
Gold  or  silver  (at  present,  with  the  gold  standard  general, 
chiefly  gold)  is  passed  from  one  country  to  another  in 
payment  for  goods  or  services  or  to  redeem  obligations. 

1  These  facts  are  mechanically  expressed  in  Fisher,  The  Purchasing  Power  oj 
Money,  pp.  96-111. 

*  For  a  fuller  statement  see  Fisher,  The  Purchasing  Power  of  Money,  pp.  go- 
96. 


LAWS  OF  MONEY 


23 


Between  different  countries,  the  gold  passes  only  by 
weight,  but  since  gold  coin  and  bullion  are  related  in  all 
gold  standard  countries,  the  effect  of  the  flow  of  gold  from 
one  country  to  another  is  to  decrease,  relatively,  the 
quantity  of  money  in  the  one  and  to  increase  it,  rela¬ 
tively,  in  the  other.  Between  parts  of  the  same  nation, 
all  legal  tender  money,  whether  gold,  silver,  or  paper, 
passes  freely. 

What  are  the  laws  of  this  flow  ?  Obviously,  money, 
like  all  things  else,  flows  to  those  places  where  it  has  the 
greatest  value,  where  it  can  buy  the  most  of  other  things. 
That  is,  money  flows  from  those  places  or  countries  where 
prices  of  goods  are  high,  to  those  places  or  countries 
where  prices  are  low.  Goods  are  bought  where  they  can 
be  bought  the  cheapest.  Money  goes  to  pay  for  the 
goods.  Hence,  money  flows  to  those  places  where  there 
are  low  prices.  But  low  prices  means  high  purchasing 
power  or  value  of  money.  Therefore  money  flows  to 
those  places  where  its  value  is  high.  When,  however, 
one  country  has  an  inconvertible  paper  money  unrelated 
to  the  money  of  another,  no  such  flow  can  take  place. 
When  paper  money  is  first  issued  in  one  country  it  tends, 
by  raising  prices,  to  cause  purchases  abroad,  where 
prices  have  not  thus  been  raised.  As  the  paper  money 
is  not  legal  tender  elsewhere,  gold  must  be  sent  to  pay 
for  the  goods  thus  bought.  The  continuing  issue  of 
paper  money  may  drive  all  the  gold  out  of  the  currency 
of  the  country  issuing  the  paper.  Until  it  does  so,  the 
effect  on  prices  applies  to  other  countries  as  well ;  the 
effect  is  distributed  over  all.  Though  the  paper  circu¬ 
lates  only  in  the  issuing  country,  it  displaces  gold  and 
pushes  the  gold  into  other  countries.  But,  when  enough 
paper  money  has  been  issued  completely  to  drive  out 


24  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


gold,  no  such  further  effect  on  other  countries  can  be 
produced.  Trade  will  still  take  place.1  Commodities  of 
one  sort  are  bought  and  commodities  of  another  sort 
are  sold .  Gold  itself  may  be  traded  back  and  forth.  But 
the  currency  of  the  one  country  is  absolutely  unrelated 
to  the  currencies  of  others. 


§  9 

Summary 


In  this  chapter  we  have  been  concerned  chiefly  with 
the  laws  of  money,  an  important  part  of  the  mechanism 
of  civilized  commerce.  We  saw,  first,  that  the  general 
level  of  prices  of  goods  varies,  other  things  equal,  with 
the  quantity  of  money.  This  fact  was  mathematically 
expressed  in  the  so-called  “equation  of  exchange,” 

MV  =  pq  +  p'q'  +  etc. 

Analysis  of  the  causal  relations  between  quantity  of 
money  and  prices  led  us  to  demand  and  supply  and  the 
ordinary  forces  of  competition  as  an  explanation.  It 
was  seen  that  increased  money  involves  higher  prices  of 
goods  to  equalize  supply  of  and  demand  for  those  goods, 
and,  conversely,  a  lower  purchasing  power  or  value  of 
money,  to  equalize  supply  of  and  demand  for  that  money. 
Supply  of  money  might  be  determined  by  government  in 
the  case  of  inconvertible  paper  but  is  generally  a  matter 
of  the  production  of  the  precious  metals,  especially  gold. 
The  possibility  of  successful  bimetallism  was  shown  to 
depend  upon  the  ratio  chosen  and  the  relative  amounts  of 
money  of  each  metal  available  under  that  ratio.  Supply 
and  demand  acting  through  the  money  and  bullion 
markets  tend  to  bring  market  ratio  to  equivalence  with 

1  See  Ch.  VI  (of  Part  I),  §§  7,  8. 


LAWS  OF  MONEY 


25 


legal  ratio,  but  may  not  have  the  effect  of  doing  this 
before  one  metal  is  driven  out  of  circulation.  The 
limping  standard  and  paper  money  were  shown  to  depend 
upon  limited  quantity  of  the  paper  money  or  the  over¬ 
valued  (in  comparison  to  weight)  silver  (or  other  metallic) 
money,  and  upon  their  legal  tender  qualities.  The 
supply  is  limited  ;  the  demand  kept  up.  Redeemability 
automatically  tends  to  prevent  oversupply  of  credit 
money  or  that  loss  of  confidence  which  decreases  demand 
for  the  money.  With  free  coinage  of  gold,  the  value  of 
gold  as  coin  and  as  bullion  tends  to  be  the  same.  Finally, 
we  saw  that  the  flow  of  money  from  place  to  place  or 
country  to  country  is  a  flow  from  where  it  is  cheap  to 
where  it  is  dear,  from  where  it  buys  little  to  where  it  buys 
much,  from  where  prices  of  goods  are  high  to  where  they 
are  low. 


« 


CHAPTER  II 

The  Nature  of  Bank  Credit 

§  i 

How  and  When  Credit  Takes  the  Place  of  Money 

Credit  is  given  whenever  goods  are  sold  for  a  promise 
to  pay,  for  a  tacit  obligation  to  pay  later,  or  for  some 
form  of  claim  upon  a  third  party  such  as  a  bank.  The 
characteristic  of  all  credit  is  the  fact  that  the  person 
disposing  of  goods  to  another  does  not  immediately 
receive  payment  in  the  form  in  which  he  is  entitled, 
ultimately,  to  receive  it ;  but  receives,  instead,  a  right  to 
future  payment,  a  right  commonly  evidenced  by  some 
kind  of  commercial  paper.  Most  frequently  this  evidence 
is  the  check  on  a  bank,  showing  the  title  of  the  receiver 
or  payee  to  money  from  the  bank  on  demand ;  or  the  bill 
of  exchange,  showing  a  title  of  the  payee  to  money  from 
the  drawee,  sometimes  on  demand  and  sometimes  on  a 
definitely  agreed  date. 

The  term  “currency”  we  shall  use  generically  to  in¬ 
clude  money,  which  is  generally  acceptable  in  exchange 
for  other  goods,  and  those  credit  rights,  less  generally 
acceptable,  which  are,  nevertheless,  largely  used  as  media 
of  exchange  and  therefore  serve  as  money  substitutes. 
Such  credit  instruments  as  checks,  bills  of  exchange,  and 
promissory  notes,  act  as  substitutes  for  money  only  if  the 
rights  to  the  sums  which  they  have  reference  to  are  trans¬ 
ferred  to  third,  fourth  and  other  parties.  Only  in  such 

26 


THE  NATURE  OF  BANK  CREDIT 


27 


cases,  therefore,  can  these  credit  instruments  or  the  rights 
which  they  certify  be  considered  as  currency.  If  a  prom¬ 
issory  note  is  given  by  one  person  to  another  and  kept 
by  the  second  until  maturity,  the  use  of  the  note  merely 
means  that  money  is  paid  from  the  one  person  to  the 
other  at  a  later  date  instead  of  an  earlier.  There  is  no 
saving  of  the  use  of  money  in  the  sense  that  credit  takes  its 
place.  But  if  A  owes  B  $100  and  B  owes  C  the  same  sum, 
and  if  A’s  promissory  note  to  B  is  used  by  the  latter  to 
pay  C,  then  the  use  of  money  is  to  some  extent  avoided. 
A  eventually  redeems  his  note  by  paying  C  the  money. 
Money  is  passed  once  instead  of  twice. 

The  ordinary  check,  sometimes  called  the  “  customer’s 
check,”  is  similarly  used.  A  may  give  to  B  a  check  for 
$100.  B,  though  he  does  not  perhaps  use  the  same  check 
to  pay  C,  uses  the  same  demand  right  or  claim  on  the 
bank.  He  sends  in  the  first  check  and  has  it  credited  to 
his  account.  Then  he  gives  his  own  check  to  C.  C 
may  collect  from  the  bank  or  may  in  turn  pay  a  fourth 
party  by  check,  and  so  on.  In  practice,  the  sums  owed 
by  the  different  parties  will  probably  not  exactly  balance. 
B  may  pay  C  by  giving  the  latter  a  check  evidencing  the 
right  to  draw  the  sum  received  by  B  from  A  plus  other 
sums  received  by  B  from  D,  E,  F,  etc.  But  however 
this  may  be,  the  principle  is  the  same.  Thus,  the  bank 
deposit,  or  right  to  draw  from  a  bank,  takes  the  place  of 
money  in  effecting  exchanges  of  goods  or  services.  The 
use  of  bills  of  exchange  also  facilitates  the  balancing 
off  of  obligations  against  each  other,  without  the  payment 
of  coin.1 


1  See  Ch.  Ill  (of  Part  I),  §  1. 


28  THE  EXCHANGE  MECHANISM  OF  COMMERCE 

§  2 

How  Commercial  Banking  is  Carried  On 

Credit  instruments,  or  credit  rights  —  for  the  paper  is 
in  each  case  but  evidence  of  the  underlying  obligation  — 
act  as  substitutes  for  money  primarily  through  the  inter¬ 
mediation  of  commercial  banking,1  and  foreign  exchange 
banking.  Commercial  banks  constitute  an  important 
part  of  the  mechanism  of  trade.  Their  work  facilitates 
internal  trade  and,  in  connection  with  the  work  of  foreign 
exchange  banks  and  brokers,  facilitates  external  trade 
as  well.  It  is  estimated  that  nine  tenths  of  the  total 
business  in  the  United  States  is  carried  on  through  the 
use  of  bank  credit.2 

Bank  deposits  (rights  to  draw  from  a  bank  or  banks), 
which  circulate  by  means  of  checks,  may  come  into  being 
in  any  one  of  several  ways.  One  may  become  a  de¬ 
positor  by  directly  depositing  money  (or  the  right  to  draw 
money,  received  by  check  from  some  one  else,  but  this 
merely  registers  a  transfer  of  a  deposit  and  does  not 
create  one) .  One  may  become  a  depositor  by  borrowing 
from  the  bank  in  which  the  deposit  is  to  be.  If  A  goes 
to  his  bank  and  leaves  there  $50,000  cash,  he  thereupon 
is  said  to  have  deposited  such  an  amount  in  the  bank 
and  can  draw  on  this  sum  at  will  by  issuing  checks  against 
it  in  favor  of  any  persons  to  whom  he  wishes  to  make 
payments.  But  A  may  also  go  to  the  same  bank,  give 
his  endorsed  note  or  other  satisfactory  security,  and  bor¬ 
row  $50,000.  This  money  he  leaves  on  deposit.  The 
bank  is  then  said  to  lend  its  credit.  What  A  has  bor- 

1  Savings  banks  and  investment  banks  perform,  of  course,  important  functions, 
but  do  not  have  a  part  in  providing  a  substitute  for  money. 

2  See  Fisher,  The  Purchasing  Power  of  Money,  New  York  (Macmillan),  ign, 
PP-  317,  3i8. 


THE  NATURE  OF  BANK  CREDIT 


29 


rowed  is  not  money  but  the  right  to  draw  money  by  check, 
at  will.  The  bank  is  under  as  much  obligation  to  redeem 
his  checks  on  demand  as  if  he  had  directly  put  money 
into  the  bank.  On  the  other  hand,  A  is  under  obligation 
to  pay  the  bank,  when  his  note  matures,  the  amount 
borrowed  plus  interest. 

It  should  be  readily  apparent  that  a  bank  can,  in  ordi¬ 
nary  times,  redeem  all  checks  presented  for  redemption, 
without  keeping  for  that  purpose  a  cash  reserve  which 
at  all  nearly  equals  its  liabilities.  The  total  value  of 
deposits  which  a  bank  is  under  obligation  to  pay  out  on 
demand,  may  be  $500,000.  Yet  it  is  certain  that  all  the 
depositors  will  not  call  for  their  money  at  the  same  time. 
Instead  of  drawing  it  out,  most  of  them  send  checks  back 
and  forth  to  and  from  others  who  do  likewise.  A  cash 
reserve  of  $100,000  may  be  ample.  Putting  the  matter 
in  the  opposite  way,  we  may  assert  that  if  there  is 
$100,000  in  cash  in  such  a  bank,  the  bank  can  lend  its 
credit,  i.e.  more  deposits  or  rights  to  draw,  to  the  extent 
of  (say)  $400,000. 

We  have  said  that  different  depositors  in  a  bank  liqui¬ 
date  their  obligations  to  each  other  by  giving  checks. 
There  is,  then,  simply  a  change  on  the  bank’s  books. 
Any  amount  of  obligations  can  be  thus  balanced.  Dif¬ 
ferent  persons  are  made  successively  creditors  of  the  bank 
for  larger  or  smaller  sums.  The  situation  is  complicated, 
but  the  principle  is  not  changed,  when  depositors  of  dif¬ 
ferent  banks  have  business  dealings  with  each  other. 
In  this  case,  which  is  a  decidedly  usual  one,  the  banks 
become  successively  each  other’s  debtors  and  creditors 
and  have  to  settle  through  a  clearing  house.  Bank  A 
may  have  accepted  and  paid  cash  for,  or  credited  to 
depositors,  many  checks  on  Bank  B.  Bank  B  therefore 


30  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


owes  Bank  A.  Similarly,  Bank  C  may  owe  Bank  B,  etc. 
All  of  these  complicated  obligations  are  balanced  by  a 
clearing  house,  so  that  each  bank  pays  what  it  owes  net 
or  receives  what  is  owed  to  it  net,  and  a  great  deal  of  flow 
of  money  is  avoided.  In  other  words,  the  principle  of 
cancellation  is  applied  whenever  possible  between  banks, 
just  as  it  is  in  any  one  bank  to  the  depositors  in  it. 

§  3 

Analysis  of  Relations  Involved  in  Commercial  Banking 

But  our  analysis  of  the  nature  of  commercial  banking 
is  not  complete  until  we  go  back  of  the  banks  and  examine 
the  relations  to  each  other,  through  the  banks,  of  those 
who  deal  with  the  banks  and  with  each  other.1 

When  a  man  borrows  from  a  bank  (giving  proper  se¬ 
curity  and  receiving  credit  on  the  bank’s  books),  he  is 
getting  command  over  present  wealth  in  return  for  a 
promise  to  repay  wealth  in  the  future.  Those  who  pro¬ 
vide  him  with  this  present  wealth  must  wait  before  being 
repaid.  Lending  always  involves  giving  up  something 
now  and  getting  something  in  the  future,  i.e.  lending 
always  involves  waiting.2  In  order,  then,  that  any  one 
may  borrow  from  a  bank,  some  person  or  persons  must  be 
the  lenders,  must  be  ready  to  give  up  goods  in  the  present 
for  goods  in  the  future,  must  provide  waiting.  The  bank 
itself  is,  for  the  most  part,  only  an  intermediary.  It 
brings  together  a  supply  of  waiting,  but  it  does  not,  to 
any  considerable  extent,  furnish  that  supply.  It  places 

1  The  argument  of  this  and  the  following  section  is  substantially  the  same  as 
that  presented  by  the  writer  in  the  Quarterly  Journal  of  Economics ,  August,  1910, 
in  an  article  entitled  “  Commercial  Banking  and  the  Rate  of  Interest.” 

1  Though  there  may  also  be  waiting  where  there  is  no  lending  but  only  in¬ 
vesting. 


THE  NATURE  OF  BANK  CREDIT 


3 1 


loanable  funds  at  the  disposal  of  borrowers,  but  it  is  not 
itself  the  ultimate  lender. 

The  persons  who  provide  the  waiting,  i.e.  who  are  the 
real  lenders,  may  be  divided  into  two  classes:  ( a ) 
those  who,  in  return  for  goods,  receive  checks  from 
borrowers  of  the  banks  (or  personal  notes  or  u  ac¬ 
ceptances, ”  which  the  banks  discount1).  ( b )  Those 
who  have  deposited  money  in  the  banks. 

Both  of  these  classes  have  claims  on  the  lending  banks, 
claims  which,  taken  all  together,  cannot  be  redeemed 
by  the  banks  except  as  those  who  have  borrowed,  those 
who  are  indebted  to  the  banks,  make  good  the  claims  of 
the  banks  on  them.  When  a  man  has  accepted  a  check 
from  one  who  has  borrowed  of  a  bank,  and  has  given 
goods  in  exchange  for  this  check,  he  has  actually  given 
present  wealth  in  exchange  for  a  mere  right  to  draw  on  the 
bank.  He  may,  therefore,  so  long  as  he  does  not  exercise 
this  right,  be  regarded  as  a  lender.  If  he  passes  a  check 
for  a  like  amount  to  another,  in  return  for  goods,  the 
other  becomes  the  lender,  since  this  other  now  has  the 
right  to  draw,  and  has  given  up  for  it  present  wealth. 
If,  instead  of  passing  a  check  to  another,  the  original 
payee  avails  himself  of  this  right  to  draw,  taking  money 
from  the  bank,  then  some  one  who  has  deposited  cash 
in  the  bank  vaults  may  be  looked  upon  as  the  lender, 
since  his  money  has  been  taken  from  the  bank  and  the 
borrower  is  expected  to  make  good  the  subtraction. 
Thus,  either  the  original  receiver  of  a  deposit  right  from 
a  borrower,  or  some  one  to  whom  he  passes  this  right,  or 
some  depositor  whose  cash  is  withdrawn  to  redeem  the 
check,  may  be  regarded  as  a  lender.  One  person  after 
another  holds,  for  a  time,  the  right  to  draw  money  from 

1  See  §  4  of  this  chapter  (II  of  Part  I). 


32  THE  EXCHANGE  MECHANISM  OF  COMMERCE 

a  bank,  and  delays  using  that  right.  In  the  aggregate, 
there  is  a  very  great  deal  of  such  delaying  or  waiting  on 
the  part  of  persons  who  are  entitled  to  money  whenever 
they  desire  it,  but  who  do  not  find  it  convenient  to  claim 
it  at  once.  Each  of  them  knows  that  he  can  collect  from 
a  bank,  at  will,  or  can  pass  his  claim  to  another,  at  will, 
for  any  desired  goods.  Y et  commonly  there  is  an  interval 
during  which  such  a  person  remains  a  creditor  or  lender, 
preferring  the  convenience  of  an  available  bank  account 
to  the  immediate  possession  of  other  goods.  Commercial 
banking  has  as  a  function  to  combine  and  coordinate 
such  sporadic  potential  lending  or  sporadic  waiting,  so  as 
to  put  at  the  disposal  of  borrowers  a  sum  total  of  actual 
lending  which  is  fairly  constant  in  amount.  If  A  leaves 
his  claim  on  a  bank  untouched  for  one  week,  B  for  two 
weeks,  and  C  for  a  week  and  a  half,  because  convenience 
so  dictates,  why  may  not  D,  in  the  meanwhile,  be  using 
the  capital  which  they  do  not  yet  wish  to  use?  By 
bringing  all  these  parties  together,  commercial  banking 
enables  D  to  get  the  use  of  capital  without  at  all  incon¬ 
veniencing  A,  B,  or  C.  Each  of  these  can  get  his  capital 
to  use  whenever  it  is  convenient,  but,  in  practice,  all  of 
them  will  not  want  it  at  the  same  time. 

It  may  be  objected  that  the  foregoing  treatment  is  too 
concrete  to  be  true.  In  any  individual  case  of  borrowing, 
it  is  perhaps  not  legitimate  to  pair  off  each  borrower  with 
one  or  more  ultimate  lenders,  assuming  that  a  particular 
holder  of  a  deposit  (or  two  or  three  such)  is  the  real  lender 
to  some  special  borrower.  Banks  bring  together  bor¬ 
rowers  and  lenders  in  large  numbers,  and  there  is  no  log¬ 
ical  way  to  assign  two  or  more  into  pairs  or  small  groups. 
But  it  cannot  be  denied  that  if  the  total  of  loans  is  taken, 
the  ultimate  lenders  are  the  total  number  of  acceptors  of 


THE  NATURE  OF  BANK  CREDIT 


33 


checks  and  depositors  of  money,  both  of  which  classes  are 
depositors  in  the  broad  sense,  because  both  are  possessors 
of  the  right  to  draw.  Since  the  receivers  of  checks  are 
as  much  holders  of  rights  to  draw,  that  is,  of  deposits,  as 
are  the  cash  depositors,  we  may  say  that  all  the  borrowers 
are  in  debt  to  all  the  holders  of  deposits  and  that  the  latter 
are  lenders  to  the  former.  When  a  borrower  of  a  deposit 
has  not  transferred  it,  he  may  be  regarded  as  indebted 
to  himself,  since  his  right  to  draw  may  be  regarded  as  in 
the  main  backed  up  by  his  own  promise  to  pay.  The 
interrelations  of  banks  through  a  clearing  house  merely 
extend  these  relations  to  persons  depositing  in,  borrowing 
from,  and  receiving  checks  on,  other  banks.  The  prin¬ 
ciples  are  the  same  as  in  the  case  of  a  single  bank. 

The  upshot  of  the  matter  is  that  modern  commercial 
banking  makes  it  possible  for  men  to  do  business  with 
each  other  by  becoming,  successively  and  alternately, 
through  the  banks  as  intermediaries,  each  other’s  debtors 
and  creditors ;  while  yet  no  one  of  them  needs  to  remain 
a  creditor  or  lender  longer  than  suits  his  convenience. 

§4 

Why  Commercial  Banking  Commends  Itself  to  Business 
Men ,  both  as  Lenders  and  Borrowers ,  so  that  Com¬ 
mercial  Bank  Credit  becomes  a  Substitute  for  Money 

Thus  bank  credit  acts  as  a  substitute  for  money.  Its 
use  is  simply  a  process  by  which  persons  become,  so  to 
speak,  successively  each  other’s  creditors,  in  such  way  as 
ultimately  to  cancel  obligations  with  only  a  little  use  of 
cash.  But  we  have  yet  to  see,  fully,  just  why  bank 
credit  is  able  to  displace  money,  to  a  large  extent,  as  a 
medium  of  exchange.  It  does  this  by  conferring  an 


D 


34  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


advantage  upon  both  borrowers  and  ultimate  lenders. 
Ultimate  lenders,  as  such,  are  benefited  by  the  conven¬ 
ience  of  a  banking  service  for  which  they  do  not  have  to 
pay.  Borrowers  are  benefited  in  that  they  can  borrow 
on  better  terms  from  banks  than  would  otherwise  be 
possible. 

We  have  already  seen  that  commercial  banking  com¬ 
bines  and  coordinates  waiting  which  would  in  any  case 
be  done.  Such  waiting  includes,  for  example,  the  wait¬ 
ing  done  by  a  man  who  has  money  in  his  pocket  which  he 
intends  to  spend.  It  may  be  a  long  time  before  he  does 
spend  it,  but  he  knows  that  at  any  time  he  may  spend  it, 
and  when  it  is  convenient  he  will  do  so.  Practically 
everybody  finds  it  desirable  to  keep  part  of  his  assets 
in  ready  cash,  to  use  as  occasion  may  require.  The 
convenience  of  having  the  ready  cash  compensates  for 
the  loss  of  the  interest  that  might  be  received  from 
various  investments,  and  so  may  perhaps  be  regarded 
as,  itself,  a  kind  of  interest.  The  same  holds  true  of  bank 
deposits  subject  to  check  demand.  Business  firms  must 
keep  part  of  their  assets  in  such  form  as  to  be  able  to  meet 
current  expenses  and  occasional  emergencies.  They 
usually  keep  considerable  amounts  to  their  credit  in  some 
bank.  Even  in  the  absence  of  banks,  money  would 
have  to  be  kept  on  hand,  and  there  would  be  a  great  deal 
of  sporadic  waiting  remunerated  only  by  the  convenience 
of  having  cash  on  hand  when  wanted. 

The  lender,  therefore,  that  is,  for  example,  the  receiver 
of  a  check  on  a  bank,  who  becomes  a  depositor  and 
supplies  waiting,  is  not  injured  but  rather  is  benefited  by 
commercial  banking.  He  can  draw  upon  his  account  at 
will,  and  this  account  is  both  safer  and  more  convenient 
(especially  for  making  large  payments  and  payments  of 


THE  NATURE  OF  BANK  CREDIT 


35 


odd  sums)  than  the  equivalent  of  ready  cash  would  be. 
There  are,  consequently,  many  persons  who  would  be  and 
are  lenders,  without  any  further  payment  of  interest  than 
the  deposit  service  of  banks.  The  lending  involves,  in 
each  case,  only  such  waiting  as  is  convenient  and  as 
would  be  done  anyway.  And  it  is  more  satisfactory  to 
have  the  bank  deposit,  thus  making  this  waiting  available 
as  lending,  than  to  keep  all  quick  assets  in  cash.  From 
the  side  of  the  ultimate  lenders,  there  is  no  difficulty  in 
seeing  how  bank  credit  may  be  substituted  for  money, 
to  a  large  extent,  with  advantageous  results.  It  should 
be  noted  that  the  ultimate  lenders  are,  by  making  their 
waiting  available  to  borrowers,  really  adding  to  the 
wealth-producing  efficiency  of  the  community.  Were 
it  not  for  this  bank  credit,  i.e.  this  combination  of 
sporadic  waiting,  borrowers  could  only  be  similarly 
provided  for  by  the  use  of  money.  But  a  quantity  of 
money  corresponding  to  such  possible  bank  credit,  sup¬ 
posing  the  money  to  be  of  standard  money  metal,  e.g. 
gold,  would  be  a  tremendous  capital  investment  and 
would  involve,  therefore,  great  expense.  An  equivalent 
additional  investment  in  other  capital,  if  made  possible  by 
a  partial  substitution  of  safe  bank  credit  for  specie  money, 
is  more  profitable  to  the  community.  The  same  total 
amount  of  capital  is  thus  made  to  produce  larger  results. 

Let  us  now  consider  the  interests  of  the  borrowers. 
They  also  will  be  ready  to  encourage  the  system,  because 
it  enables  them  to  secure  loans  at  relatively  favorable 
rates.  The  banking  system  combines  and  coordinates, 
as  we  have  seen,  a  great  deal  of  waiting  which  would  be 
done  in  any  case.  This  it  puts  at  the  disposal  of  short¬ 
term  borrowers,  so  adding  to  the  supply  of  loans.  If 
borrowers  will  avail  themselves  of  these  loans,  which  will, 


36  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


obviously,  on  the  principles  already  set  forth,  take  chiefly 
the  form  of  bank  credit  rather  than  of  cash,  a  lower  rate 
of  interest  becomes  possible.  But  it  becomes  possible 
only  because  borrowers  are  making  use  of  waiting  which 
would  in  any  case  be  done,  only  because  such  use  enables 
society  to  get  along  with  less  of  other  currency,  pre¬ 
sumably  with  less  of  gold,  and  so  enables  a  larger  amount 
of  society’s  total  capital  to  be  held  in  other  forms.1 

These  conclusions  apply  no  less  when  the  formal  ar¬ 
rangement  is  somewhat  different.  Not  infrequently 
A  buys  goods  for  which  he  gives  his  promissory  note  to 
B.  B  endorses  this  note  and  deposits  it  with  his  bank, 
and  thereby  secures  a  deposit  account.  The  bank  is 
under  obligation  to  honor  B’s  checks  upon  it  for  the 
amount  for  which  A’s  note  was  discounted.  But  A  is 
under  obligation  to  pay  the  bank.  Taking  a  large 
number  of  such  transactions,  we  may  say  that  all  the 
makers  of  notes  so  deposited,  along  with  other  debtors 
to  banks,  are  in  debt  to  all  the  holders  of  bank  deposits, 
and  that  the  latter  are  creditors  of  the  former.  Business 
takes  place  by  means  of  different  persons  assuming,  suc¬ 
cessively,  the  position  of  creditors,  through  the  banks  as 
intermediaries,  to  such  persons  as  A.  The  fact  that  spo¬ 
radic  waiting  is  brought  together,  undoubtedly  tends  to 
give  A’s  personal  note  more  value,  i.e.  makes  the  interest 

1  The  same  principle  applies  to  government  paper  money,  as  was  shown  in 
Chapter  I  (of  Part  I),  §  6.  In  that  case,  the  government  is  the  borrower  and 
pays  no  interest.  So  far  as  bank  credit  makes  impossible  the  issue  of  so  much 
paper  money  by  government,  the  lower  interest  to  borrowers  from  banks  does 
not  involve  economy  in  the  use  of  gold  and  lower  average  interest.  For  then 
the  government  itself,  having  to  borrow  by  issuing  more  bonds  than  would, 
perhaps,  be  necessary  if  it  issued  credit  money,  must  pay  interest  which,  other¬ 
wise,  it  would  not  have  to  pay.  This  conclusion  does  not  mean,  of  course,  that 
inelastic  government  paper  money  is  to  be  preferred  to  elastic  bank  credit; 
nor  does  it  mean  that  government  paper  money  is  to  be  preferred  to  bank  credit, 
on  other  accounts. 


THE  NATURE  OF  BANK  CREDIT 


37 


he  has  to  pay  somewhat  lower.  The  bank  can  give  more 
for  the  note  than  it  otherwise  could,  just  because  its  own 
creditors  will  not  all  want  cash  at  once,  just  because  its 
lending  power  (for  the  bank  is  making  itself  a  creditor  of 
or  lender  to  A)  is  made  greater  by  the  existence  of  the 
sporadic  waiting  which  it  has  combined ;  and  since  the 
bank  can  give  more  for  the  note  to  B,  B  can  give  more 
for  it  (in  goods)  to  A. 

The  principle  is  the  same  if  B  deposits,  not  A’s  promis¬ 
sory  note,  but  a  bill  (or  draft)  on  A,  payable  in  some  30 
or  60  days,  for  goods  shipped  to  A.  This  draft  will  be 
presented  to  A  for  his  signature  as  soon  as  possible. 
That  is,  A  will  be  expected  to  acknowledge  his  in¬ 
debtedness  by  “ accepting”  the  draft.1  The  bill  (or 
draft)  thus  becomes,  in  effect,  A’s  promissory  note 
indorsed  by  B. 

In  Europe,  particularly  in  England,  still  another 
method  of  securing  bank  credit  is  common.  This  is  the 
method  of  bank  acceptances.2  The  would-be  borrower, 
A,  instead  of  directly  borrowing  of  his  bank  a  checking 
account,  or  instead  of  giving  his  creditor,  B,  a  promissory 
note,  for  deposit,  if  desired,  in  B’s  bank,  or  instead  of 
having  B  make  out  a  draft  directly  upon  him,  gets  some 
bank  to  agree  to  “ accept”  ( i.e .  become  responsible  for 
the  payment  of)  drafts  which  B  may  draw  upon  this 
bank  up  to  an  agreed  amount.  A  can  then  pay  to  B 
whatever  is  owing  to  the  latter,  by  arranging  to  have  B 
draw  a  draft  upon  the  bank  with  which  the  agreement  has 

1  For  fuller  discussion  of  such  “bills  of  exchange”  and  their  security,  see 
Ch.  Ill  (of  Part  I),  §  7. 

a  For  a  description  of  acceptances  and  a  study  of  their  effects,  see  Lawrence 
Merton  Jacobs,  “Bank  Acceptances,”  National  Monetary  Commission,  1910. 
See  further,  also  in  National  Monetary  Commission,  Paul  M.  Warburg,  “The 
Discount  System  in  Europe,”  pp.  7-13. 


38  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


been  made.  The  bank  in  question  will  undertake  to 
pay  the  draft  when  it  becomes  due,  say  in  60  days.  But 
the  agreement  is  that  before  it  does  become  due,  A  shall 
provide  the  bank  with  the  necessary  funds.  The  bank 
with  which  the  agreement  is  made,  guarantees  payment 
to  B,  but  does  not  expect  to  draw  upon  its  own  resources 
in  making  such  payment.  B  can  deposit  the  draft  with 
his  own  bank  for  credit.  B  then  has  a  right  to  draw 
from  his  own  bank  on  demand ;  his  bank  has  a  claim  upon 
the  bank  with  which  A  made  the  above  described  arrange¬ 
ment;  and  this  bank  has  a  claim  upon  A.  B,  or  those 
receiving  from  him  checks  upon  his  bank,  may  be 
regarded  as  the  ultimate  creditor  or  creditors;  A  is 
obviously  the  ultimate  debtor.  The  banks  are  inter¬ 
mediaries.  Also,  the  banks  have  brought  together  the 
waiting  of  those  who  successively,  for  periods  dictated 
by  their  own  convenience,  become  creditors  of  the  bank¬ 
ing  system  by  receiving  checks  or  deposit  rights  based 
on  the  draft  for  which  A  is  ultimately  responsible. 
Further,  the  fact  that  this  sporadic  waiting  is  made 
available  as  actual  lending,  means  that  B’s  draft  on  the 
bank  will  be  discounted  at  a  somewhat  lower  rate  than  it 
otherwise  probably  could  be,  and  will  therefore  bring  a 
better  price.  Since  the  draft  for  a  given  sum  has  thus 
a  somewhat  higher  value  to  B  than  it  would  else  have,  the 
latter  will  be  ready  to  charge  A  in  payment  for  any 
definite  amount  of  goods  sold,  a  somewhat  lower  price 
than  otherwise.  In  effect,  because  of  the  waiting  made 
available  by  the  banking  system,  A  borrows  at  a  lower 
rate  of  interest.  The  same  principle  is  involved  if,  as 
frequently  happens,  A  himself  draws  a  draft  upon  a 
bank  which  agrees  to  “ accept”  it,  and  sells  it  to  another 
bank  for  credit.  Those  who  receive  A’s  checks  on  this 


THE  NATURE  OF  BANK  CREDIT 


39 


credit,  in  payment  for  goods,  are  then  the  ultimate 
lenders  in  the  sense  above  explained. 

Whatever  the  formal  arrangement  by  which  bank 
credit  is  utilized,  the  charges  to  the  borrowers  or  debtors 
(for,  in  the  last  analysis,  it  is  always  the  borrowers  or 
debtors  who  pay)  must  be  enough  to  cover  the  cost  of 
banking  service.  These  charges  must  remunerate  the 
banks  for  concentrating  waiting  where  it  has  the  greatest 
usefulness.  They  must  cover  salaries  of  bank  officials, 
depreciation  of  bank  property,  interest  on  the  capital 
invested  by  the  banks  themselves,  and  compensation  for 
the  risk  to  the  banks,  of  insolvency,  for  the  banks,  though 
chiefly  go-betweens  or  intermediaries,  do  nevertheless 
insure  the  credit  of  borrowers.  If  all  the  borrowers 
failed  to  make  good,  the  banks  must  fail;  but  within 
limits  the  banks  can  and  do  guarantee  depositors.  This 
they  do,  largely,  by  maintaining  cash  reserves  of  per¬ 
haps  yV  to  i  °f  their  deposits,  according  to  conditions 
and  the  requirements  of  law,  from  which  they  can  liqui¬ 
date  as  many  of  their  demand  obligations  as  are  likely 
to  be  suddenly  presented  for  payment  at  any  one  time. 
On  these  reserves,  as  on  their  other  capital,  the  banks 
expect  to  realize  a  reasonable  interest. 

In  other  words,  the  payments  made  by  borrowers  must 
cover  the  cost  of  banking  plus  a  fair  return  on  banking 
capital.  These  payments  would  not  do  this  if  the 
demand  for  loans  from  banks  were  very  small,  and  if 
such  demand  could  be  sufficiently  met  by  the  funds  of 
depositors  who  would  be  willing  to  pay  the  cost  of 
banking,  for  the  sake  of  the  convenience  of  banking 
service.  The  demand  for  bank  loans,  however,  is  far 
in  excess  of  what  could  be  supplied  by  means  so  trivial, 
and  is,  indeed,  sufficient  to  throw  upon  borrowers  or 


40  THE  EXCHANGE  MECHANISM  OF  COMMERCE 

i 

debtors  as  such,  the  whole  cost  of  banking  service. 
When  those  who,  through  the  intermediation  of  banks, 
are  the  ultimate  lenders  or  creditors,  have  become  such 
by  having  the  promissory  notes  of  or  drafts  on  their 
debtors  discounted,  the  creditors  may  seem  to  be  paying 
the  cost  of  banking.  But,  in  such  cases,  they  have,  pre¬ 
sumably,  made  allowances  for  the  bank  rate  of  discount, 
in  the  prices  they  have  charged  for  goods  sold,  and  the 
debtors,  therefore,  really  pay  for  the  services  of  the 
banks. 

The  payments  by  borrowers  or  debtors  may  be  re¬ 
garded,  then,  as  real  interest  payments  in  the  sense  that 
the  ultimate  lenders  profit  by  the  existence  of  a  place  of 
deposit  other  than  their  own  vaults,  for  which  they  do 
not  have  to  pay,  and  profit  further  by  the  facility  of 
check  payments  thus  made  practicable.  If  no  money 
interest  is  received  by  the  ultimate  lenders,  the  amounts 
paid  by  borrowers  are,  in  the  long  run,  because  of  the 
competition  of  different  banks,  determined  by  the  labor 
cost  of  rendering  the  service,  plus  the  interest  (including 
compensation  for  risk)  on  the  cost  value  of  the  machinery, 
such  as  buildings,  necessary  reserves,  etc.,  used  in  bring¬ 
ing  borrowers  and  real  lenders  together.  If,  however, 
there  is  not  a  sufficiency  of  this  “ convenience  waiting” 
to  be  had  to  supply  the  demand  for  loans  at  the  mere 
cost  of  concentration,  then  the  banks  will  bid  against 
each  other,  not  so  much  to  cut  down  the  charge  for  the 
service  performed  for  borrowers,  as  to  get  deposits. 
Hence  we  are  beginning  to  see  direct  interest,  though  at 
low  rates,  very  generally  offered  on  deposits  subject  to 
check,  either  on  monthly  balances  or  otherwise. 


THE  NATURE  OF  BANK  CREDIT 


4i 


§5 


Application  of  Principles  Arrived  at ,  to  Bank  Notes 

The  same  principles  apply  to  bank  notes  as  to  bank 
deposits.  The  bank  note,  when  issued  on  the  sole 
responsibility  of  a  bank,  is,  like  the  deposit,  a  credit 
obligation  of  the  bank  to  the  holder.  The  holder  is 
entitled  to  specie  or  other  legal  tender  money  on  demand. 
As  with  deposits,  these  rights  to  draw  circulate  from 
hand  to  hand  in  payment  for  goods.  And  as  with 
deposits,  the  real  lender  or  creditor  is  the  person  who 
receives  the  bank  notes,  which  represent  only  a  claim 
in  payment  for  goods  sold ;  while  the  ultimate  debtor 
is  the  person  —  or  the  persons  —  who  has  borrowed  the 
bank’s  credit  in  this  form,  either  directly  or  by  any  of  the 
methods  just  described  in  relation  to  deposits,  and  is 
under  obligation  to  repay.  The  bank  is  a  legally  re¬ 
sponsible  intermediary,  but  is  chiefly  dependent,  in  the 
long  run,  for  means  to  redeem,  on  repayment  of  loans  by 
its  debtors.  The  bank,  in  the  main,  is  merely  an  inter¬ 
mediary,  although,  as  with  deposits,  part  of  its  own  cap¬ 
ital  serves  as  an  insurance  fund  to  cover  all  contingencies 
which  are  reasonably  likely  to  occur. 

But  the  holders  of  bank  notes  are  frequently  given,  by 
government,  greater  protection  against  loss  than  the 
holders  of  deposits.  In  Canada,  for  example,  the  note¬ 
issuing  banks  have  to  contribute  to  a  special  reserve  fund 
to  redeem  the  notes  of  failed  banks,  besides  which  note 
holders  have  a  prior  lien.  In  the  United  States,  note 
holders  are  insured  against  loss  by  the  Federal  govern¬ 
ment,  which  makes  itself  ultimately  responsible  for  all 
notes  issued  in  conformity  with  the  national  banking 
law,  and,  therefore,  for  all  bank  notes  issued,  since  a 


42  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


io  per  cent  tax  on  other  bank  notes  effectually  keeps  them 
out  of  circulation.  The  notes  issued  by  national  banks 
are  based  chiefly 1  on  government  bonds.  Each  national 
bank  must  have  purchased  bonds  of  the  United  States, 
the  par  value  and  also  the  market  value  of  which  shall 
be  at  least  equal  to  all  its  notes  in  circulation.  These 
bonds  must  have  been  deposited  with  the  Comptroller 
of  the  Currency.  The  banks  must  also  have  deposited 
in  cash  a  redemption  fund  of  5  per  cent  of  the  face  value 
of  their  notes.  In  consideration  of  these  safeguards, 
the  United  States  assumes  ultimate  responsibility  for 
the  redemption  of  the  bank  notes  in  case  of  the  failure 
of  any  bank,  and,  in  fact,  undertakes  to  redeem  the  notes 
currently  for  those  persons  presenting  them,  out  of  the 
5  per  cent  redemption  fund.  These  bond-secured  bank 
notes  will,  however,  be  gradually  withdrawn  over  a  period 
of  years.  The  recent  Federal  Reserve  Act  permits  their 
gradual  retirement  and,  in  addition,  the  2  per  cent  gov¬ 
ernment  bonds,  on  which  alone  they  can  be  based,  will, 
as  they  mature,  be  permanently  withdrawn.  The  recent 
F ederal  Reserve  Act,  however,  creates  from  eight  to  twelve 2 
Federal  reserve  banks  through  which  Federal  reserve 
notes  shall  be  issued.  Back  of  these  the  Federal  reserve 
banks  must  keep  a  40  per  cent  gold  reserve,  of  which 
not  less  than  f ,  or  5  per  cent,  shall  be  in  the  Treasury  of 
the  United  States.  These  notes  are  to  be,  in  each  case, 
a  first  lien  upon  the  assets  of  the  bank  through  which 
they  are  issued.  But  the  government  makes  itself 
ultimately  responsible  for  their  redemption.  The  notes 

1  The  provisions  of  the  Aldrich- Vreeland  emergency  currency  measure  will 
shortly  be  superseded  by  those  of  the  Federal  Reserve  Act  of  1913.  The  Aldrich- 
Vreeland  Act  cannot  be  availed  of  after  July  1,  1915.  The  new  law  is  already 
(August  1914)  being  put  into  operation. 

1  Made  twelve  by  the  Organization  Board. 


THE  NATURE  OF  BANK  CREDIT 


43 


are  issued  to  the  Federal  reserve  banks  for  them  to  lend 
out,  at  the  discretion  of  the  Federal  Reserve  Board,  a 
government  regulating  body.  They  partake  in  part  of 
the  character  of  government  paper  money  and  in  part 
of  the  character  of  bank  notes.  It  is  customary  in 
European  countries  also,  to  safeguard  especially  bank 
notes  as  contrasted  with  deposits.  The  holder  of  a 
deposit  is  supposed  to  become  a  depositor  only  delib¬ 
erately  and  after  consideration  of  the  financial  soundness 
of  his  chosen  bank.  But  bank  notes  circulate  from  hand 
to  hand  as  “money,”  are  received  often  in  the  form  of 
wages  by  the  comparatively  poor,  and  are  not  usually 
scrutinized  to  see  from  what  bank  they  come;  nor  is 
the  soundness  of  the  bank  usually  considered. 

§  6 

Quantitative  Statement  of  the  Relation  of  Money ,  together 

with  Bank  Credit ,  to  Prices 

The  foregoing  explanation  of  the  nature  of  commercial 
banking  operations  makes  clear,  it  is  hoped,  that  these 
operations  economize  the  use  of  money  and  why  they  do 
economize  such  use.  The  rights  to  draw  from  banks, 
thus  circulating  in  place  of  government  or  “lawful” 
money  (whether  these  rights  are  evidenced  by  checks 
or  by  bank  notes)  we  may  call  M ',  and  the  average 
velocity 1  with  which  they  circulate,  V'.  Then  our 
equation  becomes 2 

MV  +  M'V '  =  pq  +  p'q'  +  etc.3 

1  Estimated  by  Fisher,  Purchasing  Power  of  Money ,  p.  285,  as  averaging,  in 
recent  years,  towards  50. 

2  Stated  in  Ch.  I  (of  Part  I),  §  1,  without  the  inclusion  of  bank  credit. 

8  The  equation  of  exchange  has  been  so  stated  as  to  include  credit,  by  Kem- 
merer,  Money  and  Credit  Instruments  in  their  Relation  to  General  Prices,  New 
York  (Holt),  1907,  p.  75;  and  by  Fisher,  The  Purchasing  Power  of  Money 


44  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


The  general  level  of  prices  is  somewhat  higher  and  the 
value  of  money  is  somewhat  lower,  because  of  the  addi¬ 
tional  use  of  credit.  The  conditions  of  supply  and 
demand  require  a  somewhat  higher  level  of  prices,  just 
as  we  have  seen  that  they  do  when  there  is  more  money. 
Gold  is  cheaper.  The  demand  for  it  is  less.  It  does  not 
need  to  be  produced,  and  cannot  profitably  be  produced, 
at  such  a  low  margin,  i.e.  from  such  unfavorable  sources 
of  supply,  as  would  otherwise  be  worth  while.  But 
this  bank  credit  is  not  altogether  an  addition  to  currency ; 
it  decreases  the  amount  of  gold  money,  and  so  is  largely 
a  substitution  of  a  cheaper  for  a  dearer  currency. 

But  if  bank  credit  can  thus  take  the  place  of  money,  is 
there  any  Emit  to  such  substitution  ?  Why  might  not 
credit  expand  and  prices  rise,  or  money  be  pushed  out, 
indefinitely?  The  answer  is  that  the  amount  of  bank 
credit  is  pretty  definitely  related  to  the  amount  of  money. 
In  the  first  place,  a  certain  amount  of  cash  is  needed  in  the 
banks,  to  maintain  confidence.  The  amount  so  needed 
bears  a  relation  to  the  amount  of  bank  credit,  and  must 
be  some  reasonable  per  cent  of  such  credit.  Otherwise, 
the  public  is  likely  to  become  frightened  and  demand  cash, 
and  this  cash  cannot  be  paid.  A  margin  against  such 
contingencies  is  always  essential  and,  for  national  banks 
of  the  United  States  and  Federal  reserve  banks,  as  well 
as  frequently  for  State  banks,  is  required  by  law.  Ref¬ 
erence  has  just  been  made1  to  this  requirement  in  the  case 
of  the  Federal  reserve  notes.  So  the  total  bank  credit 
is  related  to  the  total  bank  reserves  or  cash  in  the  banks.2 
Banks  maintain  the  proper  relation  between  deposits 
and  reserves,  by  adjusting  their  rates  of  interest  (or  dis- 

1  §  5  of  this  chapter  (II  of  Part  I). 

2  White,  Money  and  Banking,  third  edition,  Boston  (Ginn),  1908,  p.  197 


THE  NATURE  OF  BANK  CREDIT 


45 


count)  charged  to  borrowers.  If  the  deposits  are  in 
danger  of  becoming  too  great,  relative  to  the  reserves,  a 
higher  charge  to  borrowers  will  discourage  borrowing,  and 
so  will  limit  the  increase  of  those  deposits  which  originate 
in  the  borrowing  of  deposit  rights  (or  in  the  discounting 
of  notes  and  acceptances) . 

The  total  bank  credit  is  related,  also,  to  the  total  cash 
in  circulation.1  Bank  deposits  passed  by  means  of  checks 
are  absolutely  unavailable  for  very  many  transactions. 
They  are  unavailable  when  the  maker  of  a  check  is 
unknown,  and  they  are  unavailable,  practically,  for  small 
payments,  such  as  street  car  fares.  Even  bank  notes 
cannot  fill  up  the  entire  circulation  when,  as  is  usually 
the  case,  the  government  allows  them  to  be  issued  only 
in  relatively  large  denominations.  The  smaller  denomi¬ 
nations  are  needed  and  government  money  is  used. 
Business  convenience,  then,  also  compels  a  relationship 
between  the  quantity  of  bank  credit  and  the  quantity  of 
government  money. 

Since  the  quantity  of  bank  credit  is  related  in  these 
two  ways  to  the  quantity  of  government  coined  and 
government  issued  money,  changes  in  the  latter  tend  to 
bring  proportionate  changes  in  the  former.  It  is  still 
true  that  prices  depend  upon  the  quantity  of  money, 
though  the  dependence  is  in  part  indirect.  The  demand 
for  goods  comes  from  those  who  have  bank  credit  to 
offer  as  well  as  from  those  who  have  only  money.  And  we 
may  now  speak,  not  merely  of  the  supply  of  money  and 
the  demand  for  it,  but  of  the  supply  of  currency  (includ¬ 
ing  both  money  and  circulating  credit),  and  the  demand 
for  it. 

1  Fisher,  The  Purchasing  Power  of  Money ,  p.  50. 


46  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


Fluctuations  of  Bank  Credit 

But  though  the  amount  of  bank  credit  is  thus  related 
to  the  amount  of  money,  the  ratio  between  them  is 
slightly  rhythmic  rather  than  definitely  constant. 
During  periods  of  hope  and  confidence,  bank  credit 
tends  to  expand,  and  prices  to  rise.  During  periods  of 
distrust  and  depression,  the  volume  of  circulating  credit 
tends  to  be  smaller,  and  prices  to  be  lower.  When 
prosperity  is  generally  expected,  business  men  are 
anxious  to  extend  their  credit  by  borrowing  of  the  banks 
for  the  purchase  of  merchandise  and  for  other  business 
purposes.  The  banks  can  then  increase  their  deposits 
by  making  loans,  as  much  as  their  available  reserves  will 
permit.  When,  for  any  reason,  doubt  and  fear  prevail, 
even  low  discount  rates  may  not  induce  an  equal  amount 
of  borrowing. 

The  sharpest  changes  in  the  relation  of  the  quantity  of 
circulating  bank  credit  to  the  quantity  of  money  come  as 
the  consequence  of  panic.  So  far  as  a  panic  is  foreseen, 
the  banks  endeavor  to  prepare  themselves  for  it  by 
decreasing  their  demand  liabilities  in  relation  to  their  cash 
on  hand  or  reserves.  That  is,  they  cut  down  their  loans 
by  raising  their  rates  of  discount.  As  the  panic  spreads, 
the  necessity  of  such  a  policy  becomes  evident  to  nearly 
all  the  banks.  Any  bank  may  suddenly  find  itself  sub¬ 
jected  to  the  danger  of  a  run  upon  it,  and  dares  not 
increase  the  danger  by  making  extensive  loans.  Those 
banks  upon  which  there  actually  are  runs,  find  themselves 
with  depleted  reserves,  and  are  peculiarly  unable  to 
extend  credit.  The  bank  rate  of  discount,  then,  rises 


THE  NATURE  OF  BANK  CREDIT 


47 


rapidly,  while  the  volume  of  bank  credit,  M',  decreases, 
and  prices  fall. 

At  such  a  time  of  stress,  a  great  national  bank  (or  a 
few  great  banks)  which  keeps  large  reserves  beyond  the 
requirements  of  ordinary  years,  is  a  tower  of  strength, 
and  can  usually  prevent  any  general  collapse  of  credit. 
Such  an  institution  is  the  Bank  of  England,  which  holds 
itself  responsible  for  the  credit  structure  of  the  nation, 
and  maintains  always  an  emergency  reserve.  In  the 
United  States,  the  recent  Federal  Reserve  Act  (of  1913) 
directs  the  establishment  of  not  less  than  eight  or  more 
than  twelve 1  Federal  reserve  banks.  All  national  banks, 
and  all  other  banks  which  become  members  of  the 
system,2  are  required  to  keep  a  portion  of  their  reserves 
in  one  of  the  Federal  reserve  banks.  The  aim  is  to  have  a 
large  part  of  the  nation’s  banking  reserve  concentrated 
in  these  few  large  banks  so  that  ample  means  may  be 
available  in  time  of  panic  for  the  aid  of  any  sound  bank 
which  finds  itself  threatened  by  the  unreasoning  fear  of 
depositors.  The  Federal  reserve  banks  are  themselves 
required  to  keep  each  a  35  per  cent  reserve  in  lawful 
money  against  deposits  and  a  40  per  cent  reserve  in  gold 
against  the  Federal  reserve  notes  which  they  have  out¬ 
standing.  This  requirement  insures  the  maintenance 
in  ordinary  times  of  a  reserve  which  may  be  needed 
in  case  of  a  financial  crisis.  But  when  there  is  financial 
crisis  or  the  fear  of  it  and  many  banks  are  curtailing 
their  loans,  one  of  the  things  most  needed  is  the  assurance 
that  credit  can  be  secured  by  those  whose  assets  are  good 
and  whose  business  is  dependent  upon  credit.  At  such 
a  time  new  reservoirs  of  credit  may  need  to  be  opened 


1  Made  twelve  by  the  Organization  Board. 

3  With  a  temporary  exception  stated  in  the  act. 


48  THE  EXCHANGE  MECHANISM  OF  COMMERCE 

until  the  old  ones,  temporarily  closed,  are  again  un¬ 
locked.  The  new  law  therefore  provides  that  the 
Federal  Reserve  Board,  the  government  regulating 
body,  may  temporarily  suspend  any  of  the  reserve  re¬ 
quirements,  but  only  by  levying  a  proportional  tax  on 
the  banks  so  favored. 

But  while  it  is  desirable  that  the  violent  credit  fluc¬ 
tuations  associated  with  crises  should  be  avoided,  some 
seasonal  rise  and  fall  of  bank  credit  is  desirable.  In 
agricultural  countries,  particularly,  the  amount  of  trade 
immediately  after  the  crop  season  is  greater  than  at  other 
times,  and  an  alternate  expansion  and  contraction  of 
bank  credit,  corresponding  to  the  expansion  and  contrac¬ 
tion  of  business,  tends  to  keep  prices  more  stable  rather 
than  to  make  them  less  so.  In  the  United  States,  the 
circulation  of  the  Federal  reserve  notes  provided  for  in 
the  new  currency  bill,  and  the  gradual  retiring  of  the  old 
bond-secured  bank  notes,  will  tend  to  an  elasticity  of  bank 
credit  m  the  form  of  notes,  comparable  to,  though  perhaps 
less  than,  the  elasticity  of  deposits.  The  new  law  requires 
that  no  Federal  reserve  notes  originally  issued  by  -one 
Federal  reserve  bank  shall  be  paid  out  by  another  such 
bank  but  shall  be  sent  promptly  for  credit  or  redemption 
to  the  issuing  bank.  The  effect  of  this  provision  must 
be  to  give  at  least  some  slight  elasticity  to  the  volume  of 
these  notes.  For  the  notes  will  be  lent  out  as  business 
conditions  favor,  and  will  pass  into  circulation.  They 
will  then  be  used  by  borrowers,  along  with  other  means 
of  payment,  to  liquidate  debts  to  the  various  banks,  will 
flow  in  considerable  volume  to  the  Federal  reserve  banks, 
and  must  then  be  cancelled  against  other  debts  or  re¬ 
deemed.  Bank  deposits  in  the  United  States  are  nor¬ 
mally  elastic,  and  will  doubtless  continue  to  be  so.  The 


THE  NATURE  OF  BANK  CREDIT 


49 


banks  lend  perhaps  nearly  all  their  reserves  will  support, 
at  certain  times,  and  at  other  times  accumulate  reserves 
in  preparation  for  the  season  or  seasons  of  largest  lending. 


Summary 

Let  us  now  bring  together,  in  brief  compass,  the  main 
conclusions  of  this  chapter.  We  saw,  to  begin  with,  that 
credit  does  not  really  act  as  a  substitute  for  money  unless 
there  is  the  possibility  of  cancellation,  unless  the  same 
credit  (though  not  necessarily  the  same  paper  evidence 
of  it)  circulates  more  than  once.  It  usually  does  this 
in  the  case  of  the  bank  deposit  or  right  to  draw  from  a 
bank.  This  right  to  draw,  circulating  by  check  or  draft, 
is  a  substitute  in  trade  for  legal  tender  money,  tends 
somewhat  to  increase  the  total  supply  of  currency,  and 
tends  to  drive  out  other  currency. 

Analysis  of  the  relations  of  the  various  parties  con¬ 
cerned,  to  each  other,  showed  that,  apart  from  their 
function  of  insuring  the  credit  of  borrowers  by  risking 
some  capital  of  their  own,  banks  are  really  but  inter¬ 
mediaries  between  those  who  borrow  of  them,  and  the 
real  lenders.  These  lenders  are  the  depositors,  since  it  is 
the  depositors  who  have  given  up  present  goods  by  de¬ 
positing,  in  the  banks,  money  which  they  might  have 
spent,  by  accepting  checks  in  return  for  goods  sold, 
or  by  receiving  the  promissory  notes  of  or  drawing  drafts 
on  the  purchasers  of  the  goods,  and  having  such  notes 
or  drafts  discounted  by  banks.  If  the  borrowers  as  a 
whole  were  unable  to  repay,  then  the  banks  would  be 
unable  to  pay  the  depositors  what  the  latter  were  entitled 
to.  What  the  banks  do  is  to  bring  together  borrowers 


50  THE  EXCHANGE  MECHANISM  OF  COMMERCE 

and  lenders,  making  available  to  borrowers,  in  the  form 
of  loans,  sporadic  waiting  which  would  in  any  case  exist. 
Through  the  institution  of  commercial  banking,  trade  is 
carried  on  by  means  of  people  becoming  successively 
and  alternately  each  other’s  creditors.  The  demand  for 
loans  from  borrowers  is  sufficient  to  throw  upon  them  the 
cost  of  maintaining  the  banking  system.  Nevertheless, 
the  existence  of  that  system,  by  making  possible  the 
bringing  together  of  sporadic  waiting,  tends  to  make  the 
interest  charge  to  borrowers  lower  than  it  would  probably 
otherwise  be.  Bank  notes  involve  the  same  principles 
as  bank  deposits,  though  the  holders  of  bank  notes  are 
commonly  protected  or  insured  to  a  greater  degree  by 
government  than  depositors. 

Bank  credit  is  related  to  the  quantity  of  money  by  the 
habits  and  business  requirements  of  the  community  and 
by  the  necessity  of  a  sufficient  reserve.  But  the  relation 
between  bank  credit  and  money  is  rhythmic  rather  than 
exactly  constant.  The  fluctuations  seem  to  be,  in  large 
part,  closely  connected  with  the  alternation  of  business 
confidence  and  business  distrust,  and  with  the  occurrence 
of  panics.  The  banking  system  should  be  so  well 
organized  and  conservatively  managed  as  to  minimize 
such  fluctuations  of  credit.  On  the  other  hand,  a  certain 
degree  of  elasticity  in  bank  currency,  making  it  expand 
and  contract  according  to  the  seasonal  variations  of  trade, 
appears  to  be  desirable. 


CHAPTER  III 


The  Nature  and  Method  of  Foreign  Exchange 

§  i 

The  Function  of  Bills  of  Exchange 

In  the  last  chapter  we  saw  that  in  the  most  highly 
civilized  countries,  particularly  the  English-speaking 
countries,  the  largest  part  of  trade  is  carried  on  by  means 
of  bank  credit.  This  form  of  credit,  circulating  by  means 
of  checks,  is,  in  the  United  States,  of  almost  universal 
use  as  to  all  large  scale  dealings  within  a  city  or  other 
circumscribed  area. 

We  saw,  also,  that  the  use  of  this  bank  credit,  through 
checks  or  bank  notes,  is  merely  a  means  by  which  bor¬ 
rowers  and  lenders  are  brought  together,  the  bank 
being  but  an  intermediary ;  that  it  is  a  means  by  which 
one  person  or  firm  can  become,  in  the  sense  explained  in 
the  preceding  chapter,  a  debtor  successively  to  a  second, 
third,  fourth,  fifth,  etc.,  so  that  money  has  only  to  pass 
from  the  first  through  the  bank  or  through  two  or  more 
banks  and  a  clearing  house,  to  the  last.  All  the  inter¬ 
mediate  transactions  may  then  cancel,  or  cancellation 
may  at  times  be  complete,  so  that  no  balance  remains. 
Cancellation  of  these  serial  and  opposing  debts  thus  be¬ 
comes  our  principal  means  of  carrying  on  modern  busi¬ 
ness.  And  trade  is  still,  in  the  last  analysis,  as  in  primi¬ 
tive  barter  or  as  where  money  is  the  medium,  an  exchange 
of  goods  for  other  goods.  We  buy  goods  and  become,  in 


52  THE  EXCHANGE  MECHANISM  OF  COMMERCE 

effect,  debtors.  We  sell  goods  and  become  creditors. 
The  debts  cancel  and  we  have  traded  goods  for  goods. 

Bills  of  exchange  enable  us  to  extend  this  system  of 
credit  beyond  the  town  or  city,  beyond  the  state,  beyond 
the  nation.  Business  firms  separated  hundreds  of  miles 
from  each  other  can  become  debtors  and  creditors  of  one 
another  through  the  intermediation  of  the  banking  and 
exchange  system.  The  credit  structure  becomes  inter¬ 
national.  Through  the  commercial  and  the  exchange 
banks,  a  New  York  firm  can  become,  in  effect,  suc¬ 
cessively  the  debtor  of  a  London  firm,  another  London 
firm,  a  Glasgow  firm,  a  Berlin  firm,  a  Boston  firm,  and 
another  New  York  firm.  That  is,  these  different  business 
houses  successively  become  claimants  of  the  banking 
system,  through  their  receipts  of  checks  or  drafts  from 
one  another,  or  through  their  drawing  bills  of  exchange 
on  one  another,  or  both,  of  the  sum,  or  part  of  it,  originally 
borrowed  from  a  New  York  bank,  as  a  deposit,  by  the 
first  mentioned  New  York  firm.  In  trade  between 
nations,  or  between  widely  separated  parts  of  the  same 
nation,  credit  is  used,  debts  in  large  part  cancel,  and 
money  is  used  to  a  relatively  small  degree. 

Bills  of  exchange  or  drafts  serve  in  large  part,  then,  the 
same  purposes  as  ordinary  checks.  Over  long  distances, 
however,  whether  business  crosses  national  boun¬ 
daries  or  not,  the  “customer’s  check”  is  not  likely  to  be 
satisfactory.  The  receiver  may  have  hard  work  to  cash 
it  or  to  get  for  it  an  immediate  addition  to  his  bank 
balance.  In  the  distant  locality  to  which  the  check  is 
sent,  nobody,  probably,  knows  the  maker  well,  or  knows 
whether  the  maker’s  check  is  good.  In  this  regard,  the 
bank  draft  is  superior.  Or  the  creditor  may  not  wish 
to  wait  for  what  is  owed  to  him,  until  a  check  arrives 


METHOD  OF  FOREIGN  EXCHANGE 


53 


from  his  debtor.  In  this  regard,  a  commercial  draft  is 
superior. 

Foreign  and  domestic  exchange  are  in  principle  the 
same.  The  former  involves  payments  between  persons 
in  different  countries,  countries  which  have,  generally, 
different  currencies  and  which  are  often  separated  from 
each  other  bv  natural  barriers.  Domestic  exchange  in¬ 
volves  dealing  between  different  parts  of  the  same  coun¬ 
try,  but  parts  too  far  from  each  other  for  the  ordinary, 
convenient  use  of  checks. 


The  Nature  of  Bills  of  Exchange 

Let  us  now  inquire  what  is  the  nature  of  the  bill  of 
exchange.  Suppose,  to  take  the  simplest  possible  case, 
that  B  owes  to  A  the  sum  of  $1000,  and  that  A  owes  a  like 
sum  to  C.  The  form  of  settlement  will  be  that  of  the 
bill  of  exchange  if  A  orders  B  to  pay  C.  When  B  complies 
with  the  order,  his  debt  to  A  and  A’s  debt  to  C  are  both 
liquidated.  Usually  the  bill  of  exchange  involves  an 
exchange  banker  or  broker  as  one  of  the  parties.  But 
in  any  case  it  is  always  of  the  form :  A  orders  B  to  pay  C. 

The  reader  may  at  once  note  that  in  so  far  the  bill  of 
exchange  resembles  the  ordinary  check,  which  is,  in  fact, 
but  one  species  of  bill  of  exchange.  But  a  distinction  can 
be  made,  based  partly  upon  the  relation  of  a  bank  or 
banks  to  others  concerned.  In  the  case  of  the  “  custom¬ 
er’s  check,”  A,  the  drawer,  is  a  mercantile  or  industrial 
establishment  or  a  person,  while  B,  the  drawee,  is  always 
a  bank.  In  the  case  of  the  commercial  draft,  A  and  B 
are  usually  persons,  or  commercial  or  industrial  establish¬ 
ments  (except  that,  as  with  the  “bank  acceptances”  de- 


54  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


scribed  in  the  previous  chapter,1  B’s  bank  may  be  desig¬ 
nated  by  him  as  the  drawee  in  his  place),  while  C,  the 
payee,  is  usually,  though  not  necessarily,  a  bank.  In 
the  case  of  the  bank  draft,  both  A,  the  drawer,  and  B, 
the  drawee,  are  banks.  The  payee  may  be  a  person  or 
an  ordinary  business  firm.  Furthermore,  a  check  is 
always  a  demand  claim  (a  demand  draft  of  one  bank  on 
another  is  frequently  called  a  “check”),  while  a  draft 
may  or  may  not  be.  We  shall  have  occasion  to  notice, 
later  on,  the  significance  of  some  of  these  different  re¬ 
lations.  What  we  have  here  to  emphasize  is  that  the 
bill  of  exchange  or  draft  and  the  ordinary  check  are 
exactly  alike  in  involving  three  parties,  of  whom  one 
orders  a  second  to  pay  a  third ;  and  that  the  distinction 
rests,  in  part,  upon  the  position  which  the  bank  or  banks 
concerned,  if  any,  occupy  in  relation  to  the  other  persons 
or  person. 

§  3 


How  Bills  of  Exchange  Might  be  Used  to  Settle  Obligations , 

Assuming  no  Banks 

If  credit  is  to  serve  appreciably  as  a  medium  of  ex¬ 
change  or  substitute  for  money,  then  when  credit  is  given 
there  must  generally  be  three  parties.  When  there  are 
but  two  persons  concerned,  the  giving  of  credit  is  usually 
only  a  postponement  of  payment.  There  is  not  an 
avoidance  of  the  use  of  money,  except  in  those  com¬ 
paratively  rare  cases  where  B’s  debts  to  A  now  are 
balanced,  or  partly  balanced,  by  later  obligations  incurred 
by  A  to  B.  Then,  of  course,  credit  may  lead  to  cancella¬ 
tion.  If  three  or  more  persons  are  concerned,  in  addition 
to  banks  or  other  intermediaries  (and  even  if  banks  are 


1  §  4  of  Ch.  II  (Part  I). 


METHOD  OF  FOREIGN  EXCHANGE 


55 


included  in  the  three,  this  would  be  true  in  form),  can¬ 
cellation  always  takes  place. 

But  we  have  yet  to  see  just  how  bills  of  exchange  or 
drafts  are  used  to  balance  obligations  in  foreign  trade. 
To  begin  with,  we  shall  take,  as  being  the  simplest,  a  case 
seldom  realized  in  practice,  namely,  where  four  parties 
can  settle  up  their  various  debts  without  resort  to  any 
bank,  exchange  broker,  or  other  go-between.  Suppose 
that  an  American  merchant,  whom  we  shall  designate 
as  Ai,  owes  to  an  English  manufacturer,  Ei,  the  sum  of 
£100  ($486.65),  while  the  latter  owes  as  much  to  an 
English  merchant,  E2,  who  in  turn  owes  an  equal  sum  to 
an  American  manufacturer,  A2.  We  may  represent 
the  situation,  graphically,  as  follows  : 


owes 


> 


v 


owes 

\  ! 


Aa. r"  < - -owes - * -  Ea. 


Obviously,  if  the  parties  all  know  each  other  and  know 
of  the  situation,  they  can  very  easily  settle  all  three 
debts  with  but  one  use  of  money.  Ei  may  make  out  a 
bill  on  Ai  ordering  him  to  pay  E2.  Thus  Ei  cancels 
his  debt  to  E2.  E2  may  then  indorse  the  bill,  making 
it  payable  to  A2,  thus  liquidating  his  (E2’s)  debt  to  A2. 
Finally,  A2  presents  the  bill  to  Ai,  who  cancels  his  debt 


56  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


to  Ei  by  paying  it.  Thus,  three  debts  have  been  paid 
with  but  one  use  of  money.  Suppose  that,  in  addition 
to  the  other  debts,  A2  owes  $486.65  to  Ax.  Then  our 
diagram  would  be : 

A* - >■ - owes - » - -  £( 

I 

owes  owes 

1 

At—  C  owes - * -  E* 

A2  might  then  pay  by  indorsing  the  bill  to  Ai,  who  would, 
therefore,  have  only  to  pay  himself.  In  that  case,  four 
debts  would  be  settled  with  no  use  of  money  at  all. 

§  4 

Settlement  of  Obligations  by  Drafts  {Bills  of  Exchange), 
through  Intermediation  of  Banks,  Assuming  Creditors 
to  Draw  Drafts  on  Debtors 

Our  illustration,  however,  must  be  modified  if  it  is  to 
picture  the  usual  commercial  practice.  The  different 
parties  having  occasion  to  use  or  to  pay  drafts  or  bills  of 
exchange  cannot  be  expected,  ordinarily,  to  know  each 
other.  They  must  therefore  deal  with  middlemen,  with 
the  so-called  exchange  bankers  or  exchange  brokers. 
When  foreign  exchange  is  carried  on  through  the  inter¬ 
mediation  of  bankers  or  exchange  brokers,  each  bill  of 
exchange  is  still  of  the  form,  A  orders  B  to  pay  C.  But 


METHOD  OF  FOREIGN  EXCHANGE  57 

an  exchange  banker  is  now  in  the  position  of  both  A 
and  B,  or  of  C. 

There  are  several  ways  by  which  debts  can  be  settled 
through  the  use  of  the  exchange  banking  machinery. 
One  way  is  for  the  creditor  to  draw  upon  the  debtor, 
ordering  him  to  pay  a  bank.  Another  is  for  the  debtor 
to  remit  to  the  creditor  by  sending  the  latter  a  bank 
draft.  Let  us  take  up,  first,  cases  where  the  creditor 
draws  on  the  debtor.  We  will  suppose  the  same  four 
persons,  Ai,  A2,  Ei  and  E2,  but  will  now  assume  what 
is  the  usual,  if  not  indeed  the  universal,  fact,  that  they 
deal  with  each  other  through  middlemen.  These  middle¬ 
men  may  be  two  banking  houses  dealing  in  foreign 
exchange,  one,  Ba,  an  American  bank,  and  the  other,  Be, 
an  English  bank.  We  shall  suppose,  as  before,  that  Ai 
owes  Ei,  Ei  owes  E2,  E2  owes  A2,  and  A2  owes  Ai.  All 
that  is  needed  for  cancellation  is  that  the  parties  be 
brought  together.  Diagrammatically  this  situation  is : 


Ei  makes  out  a  draft  on  Ai  ordering  Ai  to  pay  Be.  Ei 
may  be  said  to  sell  this  draft  to  Be.  El’s  bank,  Be,  may 
then  give  Ei  the  money,  but  will  more  probably  (since 
Ei  is  likely  to  prefer  it)  put  the  amount  to  his  credit  as 


58  THE  EXCHANGE  MECHANISM  OF  COMMERCE 

a  depositor.  Be  sends  this  draft,  directly  or  indirectly, 
to  Ba  for  collection.  Ba  will  subtract  it  from  the  credit 
account  of  its  customer,  Ax.  So  far,  no  money  has  been 
used.  Ei  has  an  addition  to  his  deposit  account.  Ai 
has  suffered  a  subtraction  from  his.  Ei  has  the  claim 
on  the  banks  which  Ai  has  lost.  Ei  may  now  settle 
his  obligation  to  E2  by  a  check  on  Be.  E2  then  realizes 
an  addition  to  his  deposit  account  with  Be,  while  Ei 
suffers  a  diminution  of  his  bank  account.  Next,  A2  may 
make  out  a  draft  on  his  debtor,  E2  (or,  as  where  E2  has 
arranged  for  “ acceptances,”  directly  on  E2’s  bank), 
ordering  E2  (or  his  bank  for  him)  to  pay  Ba.  Ba  may  send 
this  draft  to  Be  for  collection.  A2  now  has  an  addition 
to  his  deposit  account  in  Ba.  E2’s  bank  account  is 
decreased.  Lastly,  A2  settles  with  Ai  by  check  on  Ba. 
Ai  has  now  an  addition  to  his  bank  account  which  may 
cancel  the  original  subtraction,  while  A2  suffers  a  sub¬ 
traction  which  may  be  equal  to  the  previous  addition. 
Four  debts  may  have  been  cancelled,  with  no  use  of 
money.  In  any  case,  there  has  been  less  use  of  money 
because  of  the  use  of  drafts,  for  the  banks  concerned  com¬ 
pare  accounts,  and  only  net  balances  have  to  be  paid  in 
money  or  in  gold.  The  use  of  bills  of  exchange  extends 
to  trade  between  nations,  and  equally  to  trade  between 
widely  separated  parts  of  the  same  nation,  the  operation 
of  the  bank  credit  system. 

Even  if  we  suppose  that  Ba  (for  example),  the  exchange 
bank  which  collects  the  draft  on  Ai,  is  not  the  bank  in 
which  A!  regularly  keeps  a  deposit  account,  nevertheless 
the  rule  that  trade  is  carried  on  by  a  cancellation  of 
credits,  still  holds.  Though  Ba,  upon  receiving  from  Be 
the  draft  drawn  by  Ei  upon  Ai,  cannot  then  directly 
subtract  the  amount  from  Ads  account,  it  can  call  on  Aj 


METHOD  OF  FOREIGN  EXCHANGE 


59 


for  payment.  Either  the  draft  will  be  made  payable 
to  Ai’s  bank  and  by  that  bank  subtracted  from  his  deposit 
there,  or  it  will  be  presented  directly  to  Ai  himself,  in 
which  case  he  will  probably  pay  it  by  giving  Ba  a  check 
on  his  own  bank.  In  any  case,  then,  Ei’s  bank  account 
will  probably  be  increased  and  Ai’s  bank  account  de¬ 
creased  by  virtue  of  the  draft. 

On  the  other  hand,  A2’s  bank  account  will  be  increased 
when  he  sells  his  draft  on  E2,  though  he  sells  this  draft 
to  an  exchange  dealer  not  engaged  in  a  regular  banking 
business.  For  such  an  exchange  dealer  will  presumably 
pay  him  for  his  draft  by  means  of  a  check  upon  some 
bank,  which  he  can  then  deposit  for  credit  in  his  own 
bank.  His  deposit  account  is  increased  and  E2’s  is 
decreased  by  the  transaction.  In  any  case,  Ba,  or  some 
other  exchange  bank,  has  to  pay  A2,  directly  or  indirectly, 
and  receives  payment,  directly  or  indirectly,  from  Ax ; 
in  any  case,  Ba  collects  one  draft  for  Be  and  sends  one 
draft  to  Be  for  collection.  In  any  case,  there  is  cancella¬ 
tion,  and  the  shipment  of  gold  is  wholly  or  partially 
avoided.  A2  may  pay  Ai  by  check  as  above  suggested, 
or,  if  they  are  widely  separated,  Ai  may  draw  a  domestic 
draft  on  A2  and  deposit  the  draft  in  his  bank  for  credit. 
The  draft  will  go  to  A2’s  bank  or  to  A2  for  collection  and 
A2’s  bank  account  will  be  decreased. 

Attending  only  to  the  international  relations  involved, 
we  may  say  that  A2’s  draft  on  E2  constitutes  part  of  the 
supply,  in  the  United  States,  of  bills  on  England.  The 
desire  of  an  American  bank,  e.g.  Ba,  to  purchase  this  bill, 
signifies  a  demand,  in  the  United  States,  for  bills  on  Eng¬ 
land.  This  demand  may  be  said,  in  the  last  analysis, 
to  result,  partly,  from  the  necessity  which  some  American 
bank  (or  banks)  is  under,  of  remitting  to  an  English 


60  THE  EXCHANGE  MECHANISM  OF  COMMERCE 

bank  or  banks,  after  collecting  for  the  latter;  and  so 
may  be  said  to  result,  to  some  extent,  from  the  supply, 
in  England,  of  commercial  drafts  on  Americans.  We 
may  assert,  therefore,  that  the  supply  of  such  commercial 
bills  on  America,  in  the  English  market,  corresponds,  in 
part,  to  demand  for  bills  on  England,  in  the  American 
market,  and,  in  part,  gives  rise  to  this  demand.  The 
basic  principle  is  of  course  similar  in  the  relations  between 
different  parts  of  the  same  country.  In  general,  supply 
in  one  place,  of  commercial  bills  on  another,  gives  rise  to 
demand  in  the  other,  for  bills  on  the  first. 

To  avoid  misunderstanding,  it  should  be  pointed  out 
that  foreign  exchange,  in  the  complications  of  practical 
business,  is  often  three  cornered,  four  cornered,  etc., 
involving  merchants  and  banks  of  several  countries. 
Thus,  Americans  may  have  purchased  goods  of  English 
merchants ;  the  latter  may  have  bought  goods  in  Ger¬ 
many  ;  and  Germans  may  have  imported  goods  from  the 
United  States.  Supposing  the  creditors  in  each  case 
to  draw  upon  their  debtors,1  there  would  be  sold  in  Eng¬ 
land,  drafts  on  merchants  in  the  United  States  ; 
in  Germany,  drafts  on  English  purchasers;  and  in 
the  United  States,  drafts  on  Germans.  The  drafts 
in  England,  on  Americans,  would  be  sent  to  American 
banks  for  collection.  The  American  banks  must  then 
settle  with  their  English  correspondents.  This  would 
create  a  demand  for  drafts  on  foreign  countries,  but 
might  not  directly  create  a  demand  for  drafts  on 
England.  For  the  American  banks  might  purchase 
drafts  on  Germany  and  send  these  in  settlement  to  their 
correspondents  in  England.  These  drafts  would  be 
collectible  through  German  banks,  which  might  settle 

1  See,  however,  §  5  of  this  chapter  (III  of  Part  I). 


METHOD  OF  FOREIGN  EXCHANGE 


61 


by  purchasing,  and  sending  to  their  English  correspond¬ 
ents,  the  drafts  on  England  drawn  by  German  exporters. 
In  practice,  then,  the  supply  in  England  of  drafts  on  the 
United  States  may  not  directly  give  rise  to  a  demand  in 
the  United  States  for  drafts  on  England.  Instead,  it 
may  lead  to  a  demand  in  the  United  States  for  drafts  on 
Germany,  and  to  a  demand  in  Germany  for  drafts  on 
England.  These  complications  should  not  be  over¬ 
looked,  but,  since  they  introduce  no  new  principle,  they 
may,  for  simplicity,  be  ignored  in  most  of  our  study. 

§5 

Settlement  of  Obligations  by  Bank  Drafts ,  when  Debtors 

Remit  to  Creditors 

Obligations  between  persons  in  widely  separated  places 
may  also  be  cancelled  through  the  use  of  bank  drafts. 
Instead  of  creditors  drawing  on  their  debtors,  the  debtors 
then  remit  to  their  creditors.  What  method  shall  be 
adopted  in  each  case  will  depend  upon  the  understanding 
between  the  parties  concerned  as  creditor  and  debtor. 
If  Ai  owes  Ei  and  is  to  pay  by  means  of  a  bank  draft, 
he  may  go  to  the  bank,  Ba,  and  request  such  a  draft 
payable  to  Ex.  This  he  will  pay  for  out  of  his  deposit 
with  Ba,  or  by  a  check  on  whatever  bank  he  has  an 
account  with,  or  (conceivably  but  rarely)  with  money. 
The  draft  Ax  gets  is  really  a  kind  of  check  made  out  by 
one  bank  on  another.  Ba  makes  out  an  order  upon  Be 
(or  some  other  English  bank)  requiring  payment  to  Ex. 
This  order  is  handed  by  the  American  bank  to  Ax,  who 
sends  it  to  Ex,  and  the  last  named  person  is  then  in  a 
position  to  present  the  draft  for  cash  or,  more  probably, 
credit,  to  Bc  or  to  his  regular  deposit  bank.  E2  may  simi- 


62  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


larly  settle  with  A2  by  getting  a  draft  from  Be  ordering 
Ba  to  pay  A2.  We  may  suppose  Ei  to  settle  with  E2  and 
A2  with  Ai  by  check,  as  before.  Or  we  may  suppose  that 
they  are  separated  from  each  other  by  considerable  dis¬ 
tances  and  likewise  settle  with  each  other  by  using  bank 
drafts.  The  matter  of  form  is  unessential.  In  any  case, 
most  obligations,  both  international  and  intranational, 
can  be  settled  by  cancellation,  through  the  banks. 

Where  settlement  is  made  by  the  use  of  bank  drafts, 
there  must,  of  course,  be  some  arrangement  between  the 
banks  concerned,  such  as  deposit  accounts  kept  by  each 
with  the  other,  so  that  all  of  these  drafts  will  be  honored 
without  question.  There  is  no  need  of  any  special 
arrangement  in  the  case  of  checks,  since  these  can  be  sent 
at  once,  and  with  no  appreciable  loss  of  time  in  transit, 
through  a  clearing  house,  to  the  bank  on  which  they  are 
drawn.  But  with  bank  drafts,  used  where  the  distances 
are  greater,  the  situation  is  otherwise. 

Where  bank  drafts  are  used,  these  constitute  part  of 
the  supply  of  drafts,  and  the  demand  for  them  is  a  demand 
by  persons  and  by  business  houses,  who  have  remittances 
to  make,  as  well  as  by  banks.  Thus,  a  part  of  the  supply, 
in  the  United  States,  of  bills  on  England  is  made  up  of 
the  drafts  of  American  upon  English  banks ;  and  a  part 
of  the  demand,  in  the  United  States,  for  bills  on  England 
is  the  demand  for  bank  drafts,  by  business  houses  having 
obligations  to  meet  in  England  and  desiring  to  meet 
them  in  that  way. 

Third,  cancellation  may  take  place  by  the  use  of  both 
of  these  methods,  i.e.  by  both  drawing  and  remitting. 
For  instance,  A2  makes  out  a  bill  on  E2  ordering  the  latter 
to  pay  Ba.  Ba  sends  it  to  Befor  collection  (or  discount). 
Ba  thus  gets  a  claim  upon  or  a  credit  with  Be.  Ai  desires 


METHOD  OF  FOREIGN  EXCHANGE 


63 


to  remit  a  bank  draft  to  Ei.  He  seeks  of  Ba,  such  a  draft. 
Ba,  having  purchased  A2’s  draft  on  E2  and  secured  a 
credit  balance  in  England,  is  able  to  sell  Ai  a  draft  on  Be 
payable  to  Ei. 

This  is  the  way  in  which,  as  a  matter  of  practice,  most 
of  our  transactions  with  England  are  settled.  When 
Englishmen  owe  us,  we  usually  draw  drafts  upon  them  or 
their  banks,  i.e.  we  draw  upon  London.  We  do  not,  as 
a  rule,  arrange  for  them  to  remit  drafts  on  New  York. 
On  the  other  hand,  if  we  owe  them,  the  understanding 
commonly  is  that  we  shall  purchase  drafts  on  London  and 
remit.  American  banks,  then,  buy  drafts  on  London 
from  those  Americans  having  English  debtors,  send  these 
drafts  to  their  London  correspondents,  and,  on  the 
balances  in  London  so  secured,  sell  drafts  on  their 
London  correspondents  to  Americans  having  English 
creditors.  The  opposite  operations  are  indeed  carried  on, 
but  they  are  much  less  common.  In  general,  it  may  be 
said  that  other  countries  draw  drafts  on  England  in 
much  larger  volume  than  England  draws  upon  them.1 

Three-cornered  exchange,  also,  may  involve  chiefly 
bills  on  London.  Thus,  if  Americans  have  exported  cot¬ 
ton  to  England  and  imported  mechanical  instruments 
from  Germany,  while  Germany  has  purchased  cloth  of 
England,  drafts  on  London  may  be  used  in  part  for  all 
three  settlements.  American  exporters  of  cotton  will 
draw  drafts  on  the  English  purchasers.  These  drafts 
may  be  used,  in  part,  by  American  banks,  for  remittances 
to  Germany,  as  a  basis  for  the  sale  of  bank  drafts  to 
American  importers  who  must  remit  to  Germany. 
German  banks  will,  in  turn,  send  these  drafts  on  the 

1  Clare,  The  A.B.C.  of  the  Foreign  Exchanges,  London  (Macmillan),  1893, 
p.  12. 


64  THE  EXCHANGE  MECHANISM  OF  COMMERCE 

English  importers  of  cotton  to  England,  in  order  to 
maintain  balances  there  for  the  sale  of  drafts  to  remit¬ 
ting  German  importers  of  cloth. 

London  is,  in  fact,  the  world’s  greatest  financial  centre. 
Partly,  perhaps,  because  banking  is  most  fully  developed 
in  England,  partly  because  of  the  magnitude  of  England’s 
foreign  trade  and  the  fact  that  payments  have  to  be  made 
to  English  exporters  by  merchants  of  all  other  countries, 
drafts  on  London  are  nearly  everywhere  in  demand. 
Sellers  of  goods,  in  most  parts  of  the  world,  usually  prefer 
to  take  advantage  of  this  fact  and  realize  on  their  sales 
at  once.  On  the  other  hand,  English  exporters  more 
usually,  though  not  always,  wait  for  remittances  from 
foreign  purchasers  of  their  goods.  The  loss  of  time 
necessarily  incident  to  exchange  transactions  falls,  then, 
except  as  it  is  allowed  for  in  higher  prices  of  goods  sold, 
more  largely  on  English  manufacturers  and  merchants 
and  less  largely  on  other  countries. 

Coming  back  to  the  consideration  of  trade  between 
England  and  the  United  States,  we  may  conclude  that 
drafts  drawn  by  American  business  houses  on  English 
business  houses  (or  upon  banks  properly  designated  by 
the  latter),  and  drafts  drawn  by  American  banks  upon 
English  banks,  are  both  part  of  the  supply,  in  the  United 
States,  of  bills  on  England.  The  demand  for  such 
bills  has  also  a  twofold  source.  It  comes,  first,  from 
those  persons  and  firms  other  than  banks,  who  have  obli¬ 
gations  to  meet  in  England  which  they  wish  to  meet  by 
remitting  bank  drafts.  Second,  the  demand  comes  from 
banks  which  may  desire  bills  of  exchange  on  England 
for  either  or  both  of  two  purposes :  in  order  to  maintain 
accounts  in  England,  against  which  they  may  sell  bank 
drafts;  and,  though  less  frequently,  in  order  to  remit 


METHOD  OF  FOREIGN  EXCHANGE  65 


funds  to  English  banks  which  are  sending  to  them,  for 
collection  and  settlement,  drafts  on  American  business 
men.  As  there  is,  in  the  United  States,  both  supply  of 
and  demand  for  exchange  on  England,  so  there  is,  in 
England,  both  supply  of  and  demand  for  exchange  on  the 
United  States.  The  case  is  similar  in  our  commercial 
relations  with  other  countries,  and  in  the  relations  of 
different  parts  of  the  United  States  itself,  to  each  other. 

§6 

How  Exchange  Banks  Make  Profits 

A  market  may  be  defined  as  the  coming  together  of 
buyers  and  sellers.  It  therefore  involves  all  the  mecha¬ 
nism  necessary  to  facilitate  their  intercourse.  One  may 
speak  of  a  general  market  or  of  a  local  market,  of  a  market 
in  one  or  in  another  place.  Thus,  there  is  the  New  York 
market  for  the  buying  and  selling  of  exchange  on  London. 
A  bank  in  New  Haven,  Conn.,  may  be  a  part  of  that  mar¬ 
ket  if  it  buys  from  and  sells  to  it.  That  market  includes, 
besides  the  commercial  and  industrial  organizations 
which  buy  or  sell  drafts,  all  middlemen  of  whatever  class 
who  engage  in  the  trade. 

The  middlemen  may  be  divided  roughly  into  three 
classes.1  First  may  be  mentioned  banks  which  do  a  reg¬ 
ular  foreign  exchange  business,  buying  bills  from  those 
who  have  them  to  sell  and  selling  their  own  drafts  on 
foreign  correspondents  to  persons  desiring  to  remit. 
Much  of  this  business  is  done  by  foreign  exchange  banks 
which  carry  on  little  or  no  other  business.  Some  of  it 
is  done  by  ordinary  commercial  banks,  such  as  United 

1  Cf.  Escher,  Elements  of  Foreign  Exchange,  New  York  (The  Bankers  Publish¬ 
ing  Company),  ign,  p.  60. 


66  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


States  National  banks,  in  addition  to  their  other  banking 
business.  Second,  we  may  call  attention  to  those  ex¬ 
change  dealers  whose  principal  business  is  to  buy  com¬ 
mercial  and  bankers’  bills,  and  to  resell  them,  chiefly 
to  banks.  Third  are  the  independent  brokers  who  make 
small  commissions  by  bringing  buyers  and  sellers  to¬ 
gether.  These  do  not  invest  their  own  capital,  do  not, 
that  is,  buy  bills  of  exchange  in  the  market,  but  assist 
those  desiring  to  sell  bills  to  find  buyers,  and  vice  versa. 

The  bankers  and  brokers  engaged  in  the  business  of 
foreign  exchange  make  their  money  from  commissions 
and  by  the  difference  between  what  they  pay  for  exchange 
and  what  they  get  for  it.  Thus,  when  a  bank  sells  its 
own  drafts  drawn  upon  a  correspondent  bank,  it  will 
probably  expect  to  receive  a  better  price  than  it  is  willing 
to  pay  for  the  commercial  drafts  it  buys  and  remits.  Its 
credit  is  probably  better  than  the  credit  of  most  mer¬ 
cantile  and  industrial  establishments,  and  its  drafts, 
therefore,  more  to  be  desired.  And  it  will  hardly  care  to 
engage  in  the  business  without  receiving  some  profit  as 
a  reward  or  payment  for  its  services. 

It  might  be  supposed  that  business  men,  e.g.  in  the 
United  States,  desiring  to  remit  to  foreign  creditors, 
would  sometimes  buy,  through  the  intermediation  of 
exchange  brokers,  the  identical  bills  drawn  by  other 
American  merchants  on  their  foreign  debtors,  instead 
of  remitting  by  means  of  bank  drafts.  This,  however, 
while  perfectly  possible,  is  seldom  done  in  practice. 
Perhaps  one  reason  is  that  the  business  man  desiring  to 
remit  has  much  more  confidence  in  the  credit  of  a  bank 
than  in  the  credit  of  any  other  company,  and  hence 
prefers  to  buy  a  claim  on  a  bank  to  use  in  remitting. 
Another  and  a  very  practical  reason  is  that  an  exchange 


METHOD  OF  FOREIGN  EXCHANGE  67 


bank  can  give  a  draft  enabling  the  debtor  to  pay  the 
exact  sum  owed.  Were  he  to  buy  merchants’  bills,  it 
would  be  difficult,  if  not  impossible,  to  make  out  an  even 
sum,  since  they  would  be  for  various  amounts  dependent 
on  the  requirements  of  previous  transactions.  It  falls, 
therefore,  to  the  lot  of  the  banks  to  buy  up  bills  of 
exchange  or  drafts  of  various  amounts,  and  sell  their  own 
drafts,  in  such  sums  as  are  desired,  against  the  credit 
they  thus  obtain  abroad. 

§7 

Various  Types  of  Drafts 

Bills  of  exchange  run  for  various  lengths  of  time  before 
payment.  Some  of  them  are  sight  drafts,  payable  on 
presentation.  Others,  30-day  bills  and  “long  bills,” 
such  as  60-day  and  90-day  bills,  are  payable  only  after 
the  lapse  of  a  definite  period  following  presentation  to  the 
drawee.  Bills  of  exchange,  furthermore,  may  be  drawn 
upon  and  by  persons  of  various  degrees  of  credit.  The 
credit  of  both  drawer  and  drawee  is  important,  since,  as 
in  the  case  of  checks,  if  the  drawee  fails  to  honor  a  bill,  the 
drawer  or  maker  of  the  bill  is  liable  to  the  payee.  Both 
of  these  considerations,  therefore,  namely  the  length 
of  time  a  bill  is  to  run,  and  the  credit  of  the  drawer  and 
drawee,  affect  the  bill’s  value. 

Bills  of  exchange  may  be  either  “clean”  bills  or  docu¬ 
mentary.1  Clean  bills  are  those  which  have  no  attached 
documents  giving  security,  but  depend  for  their  value 
and  salability  solely  on  the  reputations  of  the  drawee 
(who  must  pay  the  bill)  and  the  drawer  (who  is  respon¬ 
sible  to  the  holder  if  the  drawee  fails  to  pay).  A  bank 


1  Escher,  Elements  of  Foreign  Exchange,  pp.  45-52. 


68  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


draft  is  an  example  of  a  clean  bill.  Frequently  a  mer¬ 
chant’s  draft  on  another  merchant  is  a  clean  bill,  but 
this  is  not  so  universally  the  case. 

Very  usually  a  merchant’s  or  manufacturer’s  draft 
is  documentary,  i.e.  has  documents  attached.  Suppose 
A2  ships  £1000  worth  of  merchandise  to  E2.  He  may 
then  draw  a  bill  on  E2  ordering  the  latter  to  pay  £1000 
to  Ba.  Before  doing  this,  however,  or  at  any  rate  before 
disposing  of  the  draft,  A2  will  get  from  the  transportation 
company  by  which  the  goods  are  shipped,  a  bill  of  lading 
for  the  goods.  He  will  also,  probably,  insure  the  goods 
against  shipwreck  or  other  loss  or  damage  in  transit. 
The  bill  of  lading  certifies  the  claim  of  A2,  the  shipper, 
upon  the  transportation  company,  to  have  the  goods 
delivered  to  the  consignee.  The  consignee  eventually 
secures  the  goods  by  presenting  the  bill  of  lading  to  the 
transportation  company.  Likewise,  the  certificate  of  in¬ 
surance  certifies  A2’s  claim  upon  an  insurance  company, 
in  case  of  damage  or  loss.  A2,  having  made  out  the  draft 
on  E2,  will  attach  to  this  draft  the  bill  of  lading  and  the 
insurance  certificate,  before  disposing  of  it  to  any  bank. 
Possession  of  these  documents  is  then  some  protection  to 
the  bank  in  case  payment  is  refused.  If  neither  the 
drawee  nor  the  maker  of  the  draft  will  or  can  reimburse 
the  bank,  the  goods  may  be  sold,  because  usually  hy¬ 
pothecated,  and  the  proceeds  applied  to  that  purpose. 

A  banker,  however,  is  not,  supposedly,  an  expert  in  the 
business  of  selling  the  goods  in  question,  and  may  not 
be  able  to  realize  the  best  price  for  them  without  going 
to  considerable  expense.  Also,  the  market  may  not 
remain  steady  and  the  goods  may  not  for  that  reason 
sell  for  enough  to  cover  the  bank’s  advance.  The  busi¬ 
ness  reputation  and  the  financial  standing  of  the  maker 


METHOD  OF  FOREIGN  EXCHANGE 


69 


and  of  the  drawee  are  therefore  almost  always  of  impor¬ 
tance  in  determining  the  value  of  a  draft.  If  their  credit 
is  not  established,  the  maker  or  drawer  cannot  hope  to 
receive  quite  as  large  an  amount  for  his  bill  as  otherwise 
he  might. 

Documentary  commercial  drafts,  other  than  sight 
drafts,  may  be  “acceptance  bills”  or  they  may  be  “pay¬ 
ment  bills.”  Acceptance  is  a  formal  acknowledgment 
of  obligation  by  the  drawee.  When  a  draft  is  presented 
to  him  for  acceptance,  he  writes  the  word  “accepted” 
and  his  signature,  across  its  face.  Where,  as  in  England, 
“bank  acceptances”  are  commonly  used,  a  merchant’s 
bank  may  undertake  to  “accept”  drafts  for  him  and  so 
becomes  the  drawee.  When  an  acceptance  bill  is  drawn, 
the  drawee  has  sufficiently  good  credit  so  that  his 
acceptance  of  the  draft  gives  him  possession  of  the  bill 
of  lading  and  therefore  of  the  merchandise ;  though  the 
draft  may  be  for  90  or  120  days  after  sight,  during  which 
length  of  time  the  drawee  is  not  called  upon  for  payment. 
In  the  case  of  the  payment  bill,  the  drawee’s  credit  is 
less  good.  Though  acknowledgment  in  the  form  of 
acceptance  will  be  asked  for,  he  cannot  obtain  the 
merchandise  consigned  to  him  by  merely  accepting  the 
bill  of  exchange,  but  must  actually  pay  it.1  If,  however, 
a  30-day,  90-day  or  other  payment  bill  is  paid  by  the 
drawee  before  maturity,  he  is  allowed  a  rebate  or  dis¬ 
count  from  the  face  of  the  bill. 

In  the  case  of  perishable  goods,  e.g .  produce,  payment 
cannot  be  allowed  by  the  purchaser  to  run,  lest  the  prod¬ 
uce  spoil.  He  pays  the  draft  at  once,  therefore,  under 


1  Escher,  Elements  of  Foreign  Exchange,  p.  49.  When  documentary  drafts 
are  made  payable  a  very  few  days  after  sight,  the  documents  are  apt  to  be  de¬ 
livered  only  upon  payment.  Ibid.,  p.  52. 


70  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


the  rebate  of  interest  arrangement.1  But  this  rebate  will 
be  less  than  the  market  rate  of  discount  on  the  draft.  For 
it  is  not  to  be  expected  that  an  exchange  banker  should 
pay  a  high  price  for  a  draft,  only  to  receive  from  the 
drawee  less  than  he  paid  the  maker.  The  banker  is 
likely  to  safeguard  himself  against  such  a  contingency  by 
paying  for  the  draft  as  little  as  the  least  he  can  expect 
to  receive.  Looking  at  the  matter  from  another  point 
of  view,  we  may  say  that  the  allowance  made  for  payment 
before  maturity  is  not  likely  to  be  so  large  as  seriously 
to  affect  the  value  of  the  draft  to  the  maker  or  seller. 

Documentary  payment  bills  sent  to  England  by  Amer¬ 
ican  banks  for  collection  cannot,  in  general,  be  discounted. 
The  principal  reason  for  this  is  that  such  a  bill  is  payable 
at  the  option  of  the  drawee  on  any  date  prior  to  maturity. 
If  the  goods  are  not  perishable  and  the  drawee  does  not 
immediately  require  them,  they  may  be  warehoused 
until  he  desires  them.  When  this  time  comes,  he 
obtains  the  bill  of  lading  by  making  payment  on  the 
draft.  It  is  convenient,  therefore,  that  the  draft  should 
remain,  until  payment,  with  the  banker  who  originally 
presented  it  for  acceptance,  in  order  that  the  drawee  may 
know  where  payment  should  be  made,  when  he  desires 
to  acquire  possession  of  the  merchandise.2  On  the  other 
hand,  acceptance  bills  drawn  on  English  merchants  or 
English  banks  are  usually  sold  at  a  discount  in  the  Lon¬ 
don  discount  market  by  order  of  the  American  bank 
which  remits  them. 

1  Escher,  Elements  of  Foreign  Exchange ,  p.  49. 

2  Margraff,  International  Exchange,  Chicago  (Fergus  Printing  Co.),  1903, 
p.  1 15.  German  banks  themselves  discount  payment  bills  remitted  to  them, 
though  at  a  rate  of  discount  higher  than  the  market  rate,  while  English  banks 
do  not.  See  Margraff,  p.  135. 


METHOD  OF  FOREIGN  EXCHANGE 


§8 

The  Sale  of  Demand  Drafts  against  Remittances  of  Long 

Bills 


After  what  has  been  said  regarding  the  discount  of 
bills  of  exchange,  the  reader  will  easily  see  how  banks  can 
sell  their  own  demand  drafts  against  remittances  of  so- 
called  long  bills,  i.e.  bills  of  60  days,  90  days,  etc.  An 
American  bank,  Ba,  can  find  out  by  cable  at  what  rate 
bills  “to  arrive”  in  London  on  a  certain  date  or  by  a 
certain  steamer  will  be  discounted.  Ba  thereupon  buys 
the  bills  here  of  persons  having  debtors  abroad,  or  of 
other  bankers  or  exchange  dealers.  It  sends  these  bills 
to  its  London  correspondent,  say  Be,  with  orders  for 
immediate  discount,  i.e.  sale.  The  sum  realized  con¬ 
stitutes  a  balance  abroad  to  the  credit  of  the  American 
bank,  a  balance  upon  which  it  then  sells  its  own  demand 
drafts  1  to  Americans  wishing  to  make  remittances.  A 
demand  draft  is  sometimes  sent  by  telegraph  and  is 
then  called  a  “cable.”  2  It  should  be  noted  that  Ba  has 
a  balance  abroad  long  before  the  bills  sent  abroad  by  it 
for  credit  have  matured,  since  these  bills  it  has  ordered 
sold  in  the  London  discount  market,  and  they  have  got 
into  the  possession  of  persons  or  houses  which  buy  such 
bills  as  investments.  In  the  United  States  there  is  no 
such  discount  market.  Drafts  made  out  in  England  on 
American  debtors,  after  being  purchased  by  English 
banks,  are  forwarded  to  American  correspondent  banks 
for  collection,  but  are  generally  held,  after  “acceptance,” 
for  account  of  the  forwarding  English  banks,  until 
maturity,  instead  of  being  sold. 


1  Escher,  Elements  of  Foreign  Exchange,  p.  79. 
a  Ibid.,  p.  71. 


72  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


It  follows  that,  as  a  rule,  the  real  creditor  of  an  English 
firm  on  which  an  American  has  drawn  a  6o-day  or  90-day 
draft  is  not  the  American,  for  he  has  had  the  draft  dis¬ 
counted  and  has  received  cash  or  credit.  Nor  is  it  the 
American  bank,  which  has  had  the  draft  sold  in  the 
London  market  and  received  a  credit  balance  with  its 
correspondent  or  has  thereby  liquidated  a  debt.  It  is 
rather  the  purchaser  of  that  draft,  in  London,  who  must 
wait  (unless  he  resells  it)  60  or  90  days  until  it  matures 
and  he  can  collect  from  the  debtor  firm  in  England. 
Or  we  may  go  one  step  farther  back  and  assert  that  the 
ultimate  creditors  are  depositors  (holders  of  rights  to 
draw)  in  that  English  bank  which  buys  the  draft  in 
question,  or  from  which  the  buyer  of  the  draft  borrowed 
the  means  to  buy  it.1  On  the  other  hand,  when  a  draft 
is  made  out  by  an  English  firm  on  an  American,  payable 
say  60  days  after  sight,  the  English  bank  which  dis¬ 
counts  it  is  the  creditor,  and,  therefore,  ultimately,  its 
depositors  are  the  creditors.  For  the  draft  will  not 
usually  be  purchased  by  an  American  investor,  but  will 
be  held  by  the  correspondent  bank,  for  account  of  the 
English  bank,  until  maturity.  The  original  English 
debtor  has  received  payment,  but  for  the  time  being 
this  payment  has  come  from  other  English  capital  which 
will  only  be  reimbursed  when  the  American  firm  pays. 

As  a  matter  of  usual  practice,  however,  long  drafts  are 
not  drawn  upon  American  debtors.  The  absence  of  a 
discount  (or,  more  properly,  a  rediscount)  market  here 
means  that  importers  have  one  less  avenue  of  credit  open 
to  them.  Were  there  such  a  market,  drafts  drawn  upon 

1  “The  enormous  amount  of  bills  held  by  the  discount  companies  and  bill 
brokers  in  England  is  to  a  very  large  extent  carried  by  them  through  loans  on 
call  from  the  banks.’’  Paul  M.  Warburg,  The  Discount  System  in  Europe,  Na¬ 
tional  Monetary  Commission,  1910,  p.  18. 


METHOD  OF  FOREIGN  EXCHANGE 


73 


them  could  be  rediscounted  and  held  until  maturity  by 
whatever  bank  or  person  offered  the  best  rate.  Such  a 
bank  (and,  therefore,  ultimately,  its  depositors)  or  person 
would  be  the  real  source  of  credit.  It  is  not  easy  to  say 
just  why  we  have  not,  in  the  United  States,  a  rediscount 
market.  Custom  and  prejudice  may  be  largely  to  blame. 
In  general,  bankers  in  the  United  States  have  regarded 
it  as  evidence  of  financial  weakness  for  a  bank  to  attempt 
to  rediscount  the  notes  of  its  customers.  Furthermore, 
the  national  banking  law,  as  interpreted  by  the  courts,  has 
made  it  illegal  for  any  national  bank  to  “accept,”  for 
account  of  its  customers,  drafts  upon  it.1  In  England, 
banks  continually  accommodate  their  customers  by  thus 
accepting  drafts.  The  customer  is  responsible,  in  each 
case,  to  the  accepting  bank,  and  must  reimburse  the 
latter  before  the  draft  is  due,  but  acceptance  of  the  draft 
insures  it  and  makes  it  salable.  The  Federal  Reserve 
Act  of  1913  specifically  permits  banks  which  become 
members  of  the  system  thus  to  “accept”  drafts  drawn 
upon  them,2  and  it  empowers  the  Federal  reserve  banks 
to  rediscount  the  commercial  paper  of  member  banks. 
The  law  is  intended,  doubtless,  among  other  things,  to 
further  the  development  of  a  rediscount  market. 

§  9 

Summary 

Before  taking  up  a  study  of  the  forces  determining  the 
rate  (or  rates)  of  exchange,  let  us  briefly  restate  the  prin¬ 
cipal  conclusions  regarding  exchange,  already  reached. 
First,  taking  up  our  analysis  where  it  was  left  by  the 

1  See  Jacobs,  Bank  Acceptances,  National  Monetary  Commission,  1910, 
pp.  4;  9. 

2  Under  conditions  prescribed  by  the  law. 


74  THE  EXCHANGE  MECHANISM  OF  COMMERCE 

previous  chapter,  we  saw  that  bills  of  exchange  or  drafts 
simply  extend  to  trade  between  widely  separated  dis¬ 
tricts  the  possibilities  of  successive  debtorship  and 
creditorship  and  of  debt  cancellation,  which  in  circum¬ 
scribed  areas  are  brought  about  through  the  use  of  checks. 
As  in  the  case  of  checks,  banks  are  really  but  inter¬ 
mediaries  through  whom  and  by  whose  arrangements, 
cancellation  takes  place.  A  consideration  of  the  different 
varieties  of  method  in  settling  obligations  over  long  dis¬ 
tances  served  to  reenforce  the  general  conclusion.  These 
obligations  are  usually  settled  in  either  of  two  ways  i 
first,  the  creditor  may  draw  a  draft  upon  his  debtor 
payable  to  the  creditor’s  bank  or  to  some  other  desig¬ 
nated  party ;  second,  the  debtor  may  purchase  a  bank 
draft  with  which  to  remit  to  his  creditor.  Assuming,  in 
trade  between  England  and  the  United  States,  either  of 
these  methods  to  be  used  from  both  sides,  or  assuming 
one  method  from  one  side  of  the  water  and  another  from 
the  other  side,  we  reach  alike  the  same  result.  The  use 
of  drafts  and  the  intermediation  of  banks  make  possible 
an  international  network  of  credit  relations  which  could 
not  otherwise  exist.  The  usual  practice  is  for  American 
creditors  to  draw  on  their  English  debtors  and  for  Ameri¬ 
can  debtors  to  remit  to  their  English  creditors. 

When  the  various  ways  of  settling  obligations  through 
the  use  of  bills  of  exchange  had  been  set  forth,  we  were 
ready  to  inquire  of  what,  in  any  country,  the  supply  of 
drafts  upon  another  country  is  made  up.  We  found 
it  to  be  composed  of  two  classes  of  drafts :  those  drawn 
by  the  creditors  of  the  first  country  upon  their  debtors 
in  the  second,  offered  for  sale  to  exchange  bankers ;  and 
those  made  out  by  banks  in  the  first  country  upon  their 
correspondent  banks  in  the  second,  sold  to  debtors  in  the 


METHOD  OF  FOREIGN  EXCHANGE 


75 


first  country  who  desire  to  make  remittances  to  the 
second.  Demand  for  drafts,  also,  proved  to  have  a  two¬ 
fold  source,  springing,  on  the  one  hand,  from  debtors 
desiring  bank  drafts  for  remittance  and,  on  the  other, 
from  banks  desiring  commercial  or  bank  drafts  to  settle 
with  or  maintain  balances  in,  correspondent  banks. 
Analysis  of  the  relations  involved  made  it  clear  that 
supply  in  one  country  (or  territory)  of  drafts  upon  a 
second,  brings  about  demand  in  the  second  for  drafts  on 
the  first. 

The  exchange  market  was  briefly  described  and  it  was 
shown  how  exchange  dealers  make  a  profit  from  their 
transactions,  being  able  to  buy  exchange  somewhat  more 
cheaply  and  sell  it  at  somewhat  higher  rates,  than  mer¬ 
chants,  manufacturers,  etc.  Next,  bills  of  exchange  were 
classified  as  sight  drafts  and  long  bills,  according  to  the 
time  to  elapse  before  payment,  and  as  documentary  bills 
and  clean  bills,  according  as  documents,  such  as  a  bill 
of  lading,  do  or  do  not  secure  them ;  and  documentary 
bills,  other  than  those  payable  at  sight,  were  in  turn 
subdivided  into  acceptance  bills  and  payment  bills  ac¬ 
cording  to  what  conditions  the  drawee  must  fulfill  to 
secure  goods  consigned  to  him. 

Finally,  the  process  of  selling  demand  drafts  against 
remittances  of  long  bills  was  briefly  described.  It  was 
pointed  out  that  this  can  be  done  by  American  banks 
by  sending  drafts  on  English  firms  to  England  for  dis¬ 
count  ;  but  that  in  the  absence  of  a  rediscount  market 
here,  the  reciprocal  operation  is  unusual.  Instead,  long 
drafts  on  American  firms,  in  those  relatively  infrequent 
cases  when  they  are  drawn,  are  generally  held  till  ma¬ 
turity  for  account  of  the  remitting  London  banks.  The 
comparatively  large  discounting,  in  England,  of  bills 


76  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


drawn  by  Americans  on  their  English  debtors,  means 
that  the  capital  which  enables  the  Americans  to  get 
immediate  funds,  comes  largely  from  those  other  Eng¬ 
lishmen  or  English  banks,  who  buy  these  bills  in  the 
discount  market,  or  from  the  depositors  of  the  banks 
where  the  funds  for  purchasing  the  drafts  are  secured. 


CHAPTER  IV 


The  Rate  of  Exchange 
§  i 


The  Meaning  of  Par  of  Exchange 

Bills  of  exchange  or  drafts  are  certificates  of  property 
rights,  i.e.  they  certify  rights  to  payment  and,  therefore, 
rights  to  enjoy  the  benefits  of  various  amounts  of  wealth. 
These  rights,  like  other  property,  are  subjects  of  purchase 
and  sale,  and  have  a  price  in  any  market  where  they  are 
bought  and  sold.  Also,  the  ruling  price,  at  any  time,  of 
drafts,  like  the  price  of  other  goods,  is  fixed  by  supply  and 
demand. 

Exchange  between  countries  may  be  said  to  be  at 
par  when  a  demand  draft  on  either  country  sells  in  the 
other  for  the  equivalent  in  coin  of  its  face  value,  plus 
or  minus  only  the  insignificant  expense  of  banking  ser¬ 
vice.1  For  instance,  the  mint  par  between  England  and 
the  United  States  is  £i  =  $4.8665.  This  means  that 
the  material  (gold  1 1/1 2  fine)  in  an  English  pound  ster¬ 
ling  of  full  weight,  is  just  equal  in  value,  supposing  both 
to  be  in  the  same  place,  to  the  material  which  would 
be  contained  in  $4.8665  of  gold  coinage  (9/10  fine)  of 
the  United  States.  Exchange,  therefore,  would  be  at 
par  between  England  and  the  United  States  if  a  demand 
draft  on  London  for  £100  was  worth,  in  New  York, 


^or  a  bank  might  be  purchasing  good  commercial  sight  drafts  for  very 
slightly  less  and  selling  its  own  drafts  for  very  slightly  more. 

77 


78  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


$486.65.  In  domestic  exchange,  say  between  New  York 
and  Chicago,  par  of  exchange  is  $1  =  $1,  for  the  standard 
of  value  is  in  both  places  exactly  the  same. 

The  rate  of  exchange,  however,  may  go  above  or  fall 
below  par.  Sight  or  demand  drafts  for  the  same  amount 
may  realize  different  sums  on  different  dates.  Our 
problem  is  to  explain,  by  a  study  of  supply  and  demand, 
why  the  rate  of  exchange,  e.g.  between  England  and  the 
United  States,  ever  varies  from  par,  and  why  it  is  fluc¬ 
tuating  rather  than  steady. 

§  2 

The  Supply  of  and  the  Demand  for  Bills  of  Exchange 

At  the  beginning  of  our  discussion  on  the  rate  of  ex¬ 
change,  it  is  important  to  get  clearly  in  mind  the  mean¬ 
ing,  in  this  connection,  of  the  terms  “supply”  and 
“demand.”  In  talking  about  other  goods,  e.g.  wheat, 
we  insist  that  “supply”  means  supply  at  a  price ,  and 
that  “demand,”  likewise,  means  demand  at  a  price. 
Adopting,  here,  an  analogous  sense,  we  may  say  that 
the  supply,  in  the  United  States,  at  a  given  price  or  rate 
and  for  any  given  period,  of  drafts  on  England,  is  the  total 
of  those  drafts  which  sellers  would  part  with,  at  that 
price  or  rate.  The  supply  of  bills  tends  to  increase  as 
the  price  or  rate  rises  and  to  decrease  as  the  rate  falls.1 
On  the  other  hand,  the  demand,  in  the  United  States, 
at  a  given  price  or  rate  and  during  any  given  period,  for 
drafts  drawn  upon  English  firms,  is  the  total  of  such 
drafts  which  buyers  of  drafts  stand  ready  to  purchase 
at  that  price.  The  demand  for  drafts  tends  to  rise  as 
the  price  or  rate  falls  and  to  fall  as  the  rate  rises.2  As,  in 

1  See  §§  4,  5  of  this  Chapter  (IV  of  Part  I),  §§  i,  3  of  Ch.  V  (Part  I),  §  9  of 
Ch.  VI  (Part  I).  j  7^. 


THE  RATE  OF  EXCHANGE 


79 


the  United  States,  we  have  a  supply  of  and  a  demand  for 
bills  of  exchange  on  England,  so,  in  England,  there  is 
a  supply  of  and  a  demand  for  such  bills  on  the  United 
States.  Since  the  rate  of  foreign  exchange  is  fixed  by 
supply  and  demand,  at  the  point,  of  course,  where  supply 
and  demand  are  equal,  we  have  next  to  determine  what 
forces  affect  supply  and  what  forces  affect  demand,  and 
how  these  forces  operate. 

The  supply,  in  this  country,  of  drafts  upon  any  foreign 
country  or  upon  all  foreign  countries  together,  is  deter¬ 
mined  by  obligations,  agreements  or  desire  of  foreigners 
to  make  payments  to  us.1  This  is  obviously  the  case 
with  commercial  drafts  drawn  on  foreign  purchasers  of 
American  goods.  These  drafts  come  into  our  exchange 
market  because  foreign  debtors  are  under  business  obli¬ 
gations  to  the  makers  of  the  drafts.  But  it  is  no  less 
true  of  bank  drafts  drawn  to  accommodate  American 
debtors  wishing  to  remit.  The  bank  draft  is  drawn 
upon  a  foreign  bank  which  is,  or  which  puts  itself,  un¬ 
der  obligation  to  pay  to  the  American  bank’s  order.  A 
draft  drawn  on  a  foreign  bank  wishing  to  lend  here  for 
profit,  is  determined  by  desire  of  the  foreign  bank  so 
to  invest.  All  drafts,  therefore,  offered  for  sale  in  our 
market,  are  based  on  the  necessity  which  foreigners  are 
under  or  their  desire  to  make  payments  to  some  of  us. 

Conversely,  the  demand  here  for  drafts  on  foreign 
countries,  is  determined  by  our  obligations  to  them  and 
by  our  occasion  to  make  voluntary  payments  to  them. 
This  demand,  as  we  have  seen,2  has  a  twofold  source. 
It  comes  from  business  houses,  etc.,  which  wish  to  buy 
bank  drafts  for  remitting  to  their  creditors  and  other 

1  See,  however,  paragraph  after  next. 

2  Chapter  III  (of  Part  1),  §§  4,  5. 


8°  THE  EXCHANGE  MECHANISM  OF  COMMERCE 

persons  abroad ;  and  it  comes  from  American  banks 
which  wish  to  buy  commercial  drafts  for  remitting  to 
their  correspondents.  These  American  banks  have 
occasion  to  remit,  largely  to  maintain  foreign  balances 
on  which  to  sell  their  own  drafts,  but  partly  because 
English  firms  have  drawn  upon  American  debtors  and 
settlement  must  be  made  through  American  banks  to 
which  the  drafts  on  Americans  have  been  sent  for  col¬ 
lection.  These  American  banks  will,  therefore,  wish  to 
buy  drafts  on  England  in  order  to  remit.  The  more 
usual  practice,  as  we  have  seen,1  is  for  our  English  credi¬ 
tors  to  await  remittances  by  their  American  debtors, 
in  drafts  on  London. 

So  far  as  foreign  debtors  choose  to  settle  by  remitting 
drafts  on  American  banks,  obligations  from  abroad  to 
us  do  not  increase  the  supply,  here,  of  drafts  on  for¬ 
eign  countries.  But  the  effect  on  the  rate  of  exchange 
is  the  same,  for  our  banks,  by  honoring  these  drafts, 
in  so  far  are  relieved  from  the  necessity  of  buying  drafts 
on  foreign  countries  to  keep  square  with  their  foreign 
correspondent  banks.  In  other  words,  there  is  a  de¬ 
crease,  here,  of  demand  for  drafts  on  foreign  countries, 
instead  of  an  increase  of  supply.  But  the  rate  of 
exchange  is  affected  in  the  same  way  and  to  the  same 
extent  in  either  case. 

The  supply,  here,  of  drafts  on  foreign  countries,  may 
be  said  to  depend,  chiefly,  on  the  following  sources  of 
obligation  and  voluntary  payments  from  them  to  us, 
though  some  of  the  obligations  are  more  likely  to  be 
settled  by  remittance  and  therefore  to  increase  demand 
abroad  for  drafts  on  the  United  States  and  decrease 
demand  here  for  drafts  on  foreign  countries,  rather  than 


1  Chapter  III  (of  Part  I),  §  5. 


1 


THE  RATE  OF  EXCHANGE  81 

to  increase  supply  here  of  drafts  on  foreign  countries. 
The  items  in  group  5  are  perhaps  most  likely  to  be  settled 
by  remittances.  Following  are  the  groups : 

1.  Purchase,  abroad,  of  American  merchandise. 

2.  Purchase  by  foreigners,  from  Americans,  of  trans¬ 
portation,  banking,  insurance,  and  other  services. 

3.  Purchase,  abroad,  of  American  securities,  and 
repurchase  or  redemption  of  foreign  securities  held 
here. 

4.  Agreements  by  which  foreigners  make  short  time 
loans  to  Americans,  and  (which  amounts  to  the  same 
thing)  1  agreements  by  which  our  bankers  may  draw 
finance  bills  on  foreign  banks ;  repayment  of  such  short 
time  borrowing  done  by  foreign  banks  from  American 
banks. 

5.  Payment  of  interest,  dividends,  rent,  etc.,  on 
American  investments  abroad,  remittances  to  Euro¬ 
peans  travelling  in  the  United  States,  etc. 

On  the  other  hand,  the  demand,  here,  for  drafts  on 
foreign  countries,  depends  in  the  main  on  corresponding 
sources  of  obligation  and  voluntary  payments,  as  follows : 

1.  Purchase,  by  Americans,  of  merchandise  from 
foreign  countries. 

2.  Purchase,  by  Americans  from  foreigners,  of  trans¬ 
portation,  banking,  insurance,  and  other  services. 

3.  Purchase,  by  Americans,  of  foreign  securities,  and 
repurchase  or  redemption  of  American  securities. 

4.  To  make  short  time  loans  abroad,  to  repay  short 
time  loans  from  abroad  and  (which  is  fundamentally 
the  same  thing)  to  repay  obligations  incurred  by  Ameri¬ 
can  banks  which  have  drawn  finance  bills  on  foreign 
banks. 

1  See  §§  4,  5  of  this  Chapter  (IV  of  Part  I). 

G 


82  THE  EXCHANGE  MECHANISM  OF  COMMERCE 

5.  Payment  of  interest,  dividends,  rent,  etc.,  to 
foreigners  who  have  invested  money  here,  remittances 
to  Americans  travelling  abroad,  remittances  to  families 
abroad  of  immigrants  living  here,  etc. 

Though  the  lists  above  given  correspond,  it  must  not 
be  assumed  that  the  payments  in  one  direction  under 
any  particular  item  are  the  equivalent  of  the  payments 
under  the  same  item  in  the  other  direction.  In  many 
cases  the  difference  is  very  great.  Thus,  practically 
nothing  is  paid  by  foreigners  to  Americans  for  the  trans¬ 
portation  of  goods,  unless  we  include  in  this  item  the 
transportation  in  the  United  States  itself,  of  goods 
eventually  to  be  shipped  abroad.  But  Americans 
pay,  every  year,  millions  of  dollars  to  Englishmen  for 
the  transportation  services  of  Great  Britain’s  merchant 
marine.  Similarly,  the  balance  of  payments  for  bank¬ 
ing  services  would  be  against  the  United  States,  since 
London  is  the  principal  banking  center  of  the  world. 
Again,  remittances  by  immigrants  in  the  United  States 
to  their  families  in  Europe  would  not  be  balanced  by 
payments  of  any  similar  nature  made  by  Europeans  to 
people  here.  Contrariwise,  payments  by  Europeans 
to  Americans  for  merchandise  might  be  considerably 
in  excess  of  similarly  caused  payments  in  the  opposite 
direction. 

Since  the  United  States  is  still,  in  large  part,  an  agri¬ 
cultural  country,  its  exports  tend  to  be  periodic  rather 
than  uniform.  The  largest  exports  from  the  United 
States  are  in  the  fall  after  the  crops  have  been  harvested. 
But  the  things  we  buy  flow  to  us  in  a  more  steady  stream. 
Hence  there  is,  in  the  fall,  a  relatively  large  supply  of 
drafts  on  foreign  countries,  for  sale  in  the  United  States, 
and  a  comparatively  low  price  for  them  or  low  rate  of 


THE  RATE  OF  EXCHANGE 


S3 


exchange.1  Banks  can  then  purchase  these  bills  more 
cheaply  as  a  rule  than  at  other  times,  and  will  therefore 
be  able  to  sell  their  own  demand  drafts  at  lower  rates. 


§  3 

The  Effect  on  the  Exchange  Market  of  any  Country 
of  Disturbed  Political  or  Industrial  Conditions  in 
That  Country  and  in  Other  Countries 


Investments  for  long  periods,  nowadays,  take  place 
largely  through  the  purchase  of  stocks  and  bonds, 
though  also  through  the  purchase  of  real  estate,  the 
loaning  to  individuals  on  mortgage  security,  etc.  The 
buyer  of  a  bond  is  a  lender  to  the  government  or  company 
whose  bond  he  buys.  The  buyer  of  stock  has  a  right 
to  residual  gains.  The  entire  western  European  world 
is  now  a  possible  market  for  American  securities,  whether 
these  securities  represent  public  or  corporate  indebt¬ 
edness  or  rights  to  corporate  profits.  To  some  extent, 
the  United  States  furnishes  a  market  for  European 
securities,  but  to  a  far  less  extent.  Europeans  have,  in 
the  past,  invested  more  here  than  Americans  have  in¬ 
vested  in  Europe.  The  English  people,  for  instance, 


1  The  truth  of  this  statement  is  evidenced  by  statistics  compiled  by  one  of 
my  students,  Mr.  Lawrence  M.  Marks,  Yale  1914,  from  successive  volumes 
of  the  Commercial  and  Financial  Chronicle.  Taking  the  highest  and  lowest 
quotations  for  each  month,  of  exchange  on  London,  and  averaging  all  the  Janu¬ 
aries,  all  the  Februaries,  etc.,  for  the  years  1906-1910  inclusive,  Mr.  Marks  ar¬ 
rived  at  the  following  results : 


January  4.872 
February  4.875 
March  4.8725 
April  4.8715 
May  4.875 
June  4.876 


July  4.872 

August  4.8685 
September  4.866 
October  4.8665 
November  4.8695 
December  4.869 


Cf.  also  Clare,  The  A.  B.  C.  of  the  Foreign  Exchanges,  London  (Macmillan), 
1893,  pp.  135,  136. 


84  THE  EXCHANGE  MECHANISM  OF  COMMERCE 

have  been  large  accumulators,  and  so  have  forced  the 
rate  of  interest  in  England  down  to  a  comparatively 
low  level.  Here,  the  rate  of  interest  has  been  higher. 
Consequently,  Englishmen  have  made  large  purchases  of 
American  securities.  And,  to  a  considerable  extent, 
they  still  hold  these  securities,  despite  the  tendency 
during  the  last  few  decades  for  American  industry  to 
be  financed  in  greater  degree  by  American  capital. 

Largely  because  of  foreign  interest  in  American  se¬ 
curities,  the  exchange  market  may  sometimes  be  much 
affected  by  American  financial  troubles.  If,  for  a  while, 
prosperity  threatens  to  forsake  us,  many  foreign  holders 
of  our  corporate  securities  may  become  alarmed  and 
endeavor  to  dispose  of  their  holdings  even  at  sacrifice 
quotations.  American  capitalists  may  therefore  be 
induced,  to  some  extent,  to  buy  these  securities  back 
again.  So  far  as  this  effect  is  realized,  there  is  a  ten¬ 
dency  for  the  rate  of  exchange  on  other  countries,  i.e. 
the  price  of  drafts  on  these  countries,  to  rise.  For  it 
puts  American  investors  under  obligation  to  remit  to 
those  from  whom  securities  have  been  purchased;  or, 
if  the  foreign  sellers  have  drawn  drafts  upon  America, 
then  American  banks  must  purchase  drafts  on  foreign 
countries  in  order  to  settle  with  their  correspondents. 
In  either  case,  the  demand,  here,  for  drafts  on  other 
countries  rises. 

If,  on  the  other  hand,  investments  which  Americans 
may  have  in  other  countries,  e.g.  in  Mexico  or  in  certain 
of  the  South  American  republics,  seem  to  be  rendered 
unsafe  because  of  threatened  political  disturbance  or 
open  revolution,  then  the  endeavor  of  Americans  to  dis¬ 
pose  of  such  investments  will  tend  to  increase  the  supply 
of  drafts  on  such  countries  and  so  may  lower  the  rate 
at  which  these  drafts  sell. 


THE  RATE  OF  EXCHANGE 


85 


§4 

Analysis  of  the  Relations  Involved  in,  and  Explanation 
of  the  Results  of,  Short  Time  l^oans  Made  Ostensibly 
by  Foreign  Banks,  through  the  Intermediation  of  the 
Exchange  Market 

One  of  the  sources  given  in  our  lists,  of  the  supply  in 
one  country  of  drafts  on  another  or  others,  is  short  time 
“loans”  ( e.g .  60  or  90  days)  by  banks.  Some  of  the 
banks  in  one  country  may  choose  to  “lend”1  in  another 
country.2  Let  us  suppose  that  a  London  bank,  Be, 
wishes  to  “lend,”  in  the  United  States,  the  sum  of 
$50,000.  It  would  cable  its  New  York  correspondent, 
Ba,  to  draw  on  it  a  draft  payable  in  perhaps  90  days  after 
sight.  This  draft  could  be  sold  in  New  York  to  another 
exchange  dealer  or  banker,  and  the  sum  realized  loaned, 
for  account  of  the  London  bank,  to  an  American  firm 
or  business  man. 

The  loan  made  may  be  a  so-called  “sterling”  (like¬ 
wise  mark  or  franc)  loan,  or  it  may  be  a  “currency” 
loan.3  In  the  case  of  the  sterling  loan,  it  is  agreed  that 
the  foreign  bank  shall  receive  a  definite  commission  or 
payment  from  the  borrower,  for  allowing  him  to  raise 
money  by  a  draft  upon  it.  If  the  loan  is  a  sterling  loan, 
the  borrower  (the  American  business  house  getting  the 
use  of  the  funds)  takes  the  risk  of  fluctuation  in  the  rate 
of  exchange  during  the  life  of  the  loan.  The  American 
bank,  Ba,  draws  a  draft  on  Be  payable  to  the  American 
borrower.  This  draft  is  for  so  many  pounds  sterling. 
Hence  the  arrangement  is  called  a  “sterling”  loan. 

1  Who  is  the  real  lender  will  appear  later  in  this  section. 

2  See  descriptive  discussion  in  Escher,  Elements  of  Foreign  Exchange,  New  York 
(The  Bankers  Publishing  Co.),  ign,  pp.  85,  86. 

3  Ibid.,  p.  87. 


86  THE  EXCHANGE  MECHANISM  OF  COMMERCE 

The  borrower,  to  whom  the  draft  is  given,  gets  his  money 
or  his  bank  credit  by  disposing  of  the  draft  at  the  best 
price  he  can  get.  When  the  90  days  are  up,  it  devolves 
upon  him  to  purchase  a  demand  draft,  payable  to  the 
lending  bank,  Be,  and  turn  it  over  to  Ba  for  remittance. 
The  lending  bank  must  honor,  at  the  end  of  the  90  days, 
the  draft  drawn  on  it  by  Ba,  for  this  will  have  reached 
London,  and  payment  will  be  due  90  days  after  pres¬ 
entation.  But  Be  will  by  that  time  have  received  the 
bank  draft  purchased  by  the  borrower,  and  so  will  be 
able  to  pay  without  any  drain  on  its  resources.  It  has 
gone  through  the  form  of  lending  while  not  parting  with 
a  single  pound.  It  has  only  taken  upon  itself  the  obli¬ 
gation  to  pay,  90  days  after  sight,  a  sum  which  it  was 
practically  certain  to  receive  (although  there  was,  of 

course,  some  risk)  equally  soon  from  the  American 
borrower. 

The  currency  loan  is  different  only  in  the  formal 
arrangements.  It  serves  the  same  purpose.  Ba  does 
not,  in  this  case,  hand  over  the  draft  on  Be,  for  the  bor¬ 
rower  to  sell,  but  itself  sells  the  draft  to  another  bank 
or  dealer.  It  then  gives  the  borrower  cash  or  credit 
in  terms  of  American  currency.  That  is  why  it  is  called 
a  currency  loan.  The  borrower  gets  dollars,  not  a 
claim  to  pounds  sterling  requiring  to  be  converted  into 
dollars.  When  the  time  comes  for  repayment,  the  bor¬ 
rower  settles  with  Ba  and  Ba  settles  with  Be.  The  bor¬ 
rower  pays  an  agreed  rate  of  interest.  The  lending 
bank,  Be,  is  subject  to  a  risk  of  fluctuation  in  the  rate 
of  exchange.  If  this  bank  foresees  a  probability  that 
exchange  will  fluctuate  favorably  to  it,  then  it  will  prefer 
to  make  the  currency  loan ;  if  unfavorably,  it  will  prefer 
to  make  the  sterling  loan. 


THE  RATE  OF  EXCHANGE 


87 


We  have  seen  that  the  so-called  lending  bank,  Be, 
is  at  no  time  out  actual  funds  by  virtue  of  its  transac¬ 
tion.  It  lends  only  in  name.  Yet  the  American  bor¬ 
rower  gets  funds  in  the  form  of  cash  or  bank  account, 
and  eventually  buys  goods  with  these  funds.  Some¬ 
where  there  is  a  real  lender,  an  ultimate  creditor.  Who 
and  where  is  he  ?  The  answer  is :  he  is  the  man  or  firm 
who  buys  the  draft  when  it  is  offered  for  sale  in  the 
London  discount  market,  or  the  depositors  of  the  bank 
from  which  this  man  or  firm  borrowed  the  means  to 
buy.  For  the  draft  on  Be,  having  been  sold  in  the  United 
States  to  an  exchange  dealer  or  bank,  would  be  sent  by 
the  American  bank  to  its  correspondent  bank  in  London, 
and  by  the  latter  sold  to  whoever  cared  to  invest  in  it. 
This  English  investor  it  is,  or  the  depositors  of  a  bank 
from  which  he  borrows,  who  gives  up  early  income  for 
later.  He  (or  they)  is  giving  up  present  goods  for  future 
goods.  He  is  the  one,  or  these  depositors  are  the  ones, 
because  of  whose  accumulations  the  whole  transaction 
is  possible.  The  American  business  man  borrower 
gets,  if  not  cash,  a  bank  account,  just  as  if  he  borrowed 
it  from  Ba,  and  with  this  bank  account  he  buys  goods. 
But  instead  of  being  indebted  to  Ba  and  through  Ba  to 
its  depositors,1  he  is  indebted,  in  the  case  of  the  sterling 
loan,  to  Be,  through  Be  to  the  English  purchaser  of  the 
draft,  and  through  him  to  the  depositors  in  any  bank 
from  which  he  gets  the  means  to  purchase ;  in  the  case 
of  the  currency  loan,  to  Ba,  through  Ba  to  Be,  through 
Be  to  the  English  purchasers  of  the  draft,  and  finally 
to  depositors  in  this  purchasers  bank.  The  English 
bank  is  but  a  nominal  lender.  The  English  (or  other) 
purchaser  of  the  draft  in  the  London  discount  market, 

1  See  Ch.  II  (of  Part  I),  §  3. 


88  THE  EXCHANGE  MECHANISM  OF  COMMERCE 

and,  in  the  last  analysis,  the  depositors  in  his  bank,  are 
the  real  lenders.  In  Chapter  II  we  saw  that  commercial 
banking  combines  and  coordinates  sporadic  convenience 
waiting  so  as  to  make  available  to  borrowers  in  the  form 
of  loans,  a  considerable  amount  of  this  waiting,  waiting 
which  would  in  any  case  be  done  because  of  convenience, 
and  which,  except  for  commercial  banking,  would  be 
of  no  use  to  borrowers.  Here  we  see  that  the  sporadic 
waiting  done  by  bank  depositors  in  one  country,  may 
be  the  means  of  providing  borrowers  in  another  country, 
with  funds.  As  is  to  be  expected,  the  waiting  or  ultimate 
lending,  in  the  case  of  these  drafts,  is  done  more  largely 
abroad,  and  the  borrowing  so  made  possible  is  done  more 
largely  by  Americans. 

Foreign  loans  of  the  kinds  we  have  been  describing, 
i.e.  sterling  and  currency  loans,  may,  if  most  largely 
made  in  the  spring  and  early  summer,  help  to  tide  over 
the  periods  of  the  year  when  the  United  States  has  a 
surplus  of  payments  to  make  abroad,  so  that  these 
payments  need  not  be  so  large.  Instead  of  our  sending 
large  amounts  of  specie  abroad,  English  purchasers,  in 
the  London  discount  market,  of  drafts  drawn  upon 
lending  London  banks,  and,  through  these  purchasers, 
depositors  in  English  banks,  may  become  temporarily 
our  creditors.  They  lend  to  us  by  providing,  for  a  time, 
the  capital  to  liquidate  obligations  from  us  to  English 
manufacturers  and  merchants,  obligations  for  which, 
if  we  could  not  get  temporary  credit,  specie  would  have 
to  flow.  Then  when  the  crop  season  comes  and  the 
pressure  of  obligations  is  more  markedly  the  other  way, 
we  pay  the  holders  of  these  drafts  by  transferring  to 
them  part  of  our  claims  upon  purchasers  of  our  exports. 
Instead  of  money  flowing,  first  from  here  to  England,  for 


THE  RATE  OF  EXCHANGE 


89 


example,  and  then,  in  the  fall,  from  England  back  to  us, 
less  will  have  gone  either  way.1  During  the  winter, 
spring,  and  early  summer,  our  net  indebtedness  abroad 
would  perhaps  have  required  considerable  gold  ship¬ 
ments.  But  any  drafts  drawn  during  this  period  upon 
English  banks,  nominally  lending  banks,  are  available 
for  purchase  by  American  exchange  bankers  who  must 
make  remittances  abroad.  The  shipment  of  gold  abroad 
is  thus  avoided.  Then  in  the  fall  when  we  are  selling 
considerable  amounts  of  grain  and  other  products  and 
drafts  on  England  are  low  in  price,  and  when  large  im¬ 
ports  of  gold  might  result,  in  payment  for  our  exports 
of  wheat,  cotton,  etc.,  these  imports  of  gold  are  made 
less  by  the  fact  that  those  Americans  who  have  received 
the  temporary  loans  (or,  in  the  case  of  currency  loans, 
the  banks  which  act  for  them)  have  now  to  liquidate 
their  obligations  by  purchasing  drafts  on  London. 

The  comparatively  high  rates  of  exchange  on  [England 
during  the  seasons  when  we  are  exporting  less  than  we 
are  importing,  and  the  comparatively  low  rates  in  the 
fall,  tend  to  make  these  dealings  worth  while.  Those 
who  thus  borrow  during  our  surplus  importing  season, 
e.g.  late  spring  or  early  summer,  sell  their  drafts  at  a 
relatively  high  price  and  buy  later  for  remitting,  if  in 
the  fall,  at  a  lower  price.  The  London  bank  which 
engages  in  the  operation  will  intend  to  receive  its  share 
of  the  gain  resulting  from  this  situation ;  at  least  in 
the  case  of  the  currency  loan,  as  we  have  seen, 2  it  clearly 
gets  the  benefit  of  a  favorable  movement  in  the  rate  of 
exchange  on  London ;  and  we  should  therefore  expect 

1  Cf.  Goschen,  The  Theory  of  the  Foreign  Exchanges,  third  edition,  London 
(Effingham  Wilson),  1896,  pp.  38-41. 

2  See  description  at  beginning  of  this  section. 


go  THE  EXCHANGE  MECHANISM  OF  COMMERCE 

it,  other  things  equal,  to  engage  most  gladly  in  the  lend¬ 
ing  operation  described,  at  the  very  times  when  its 
doing  so  would  avoid,  or  decrease  in  amount,  successive 
and  opposite  shipments  of  gold. 

§5 

Finance  Bills ,  What  they  Are ,  Whose  Accumulations  Make 
them  Possible  and  What  are  their  Results 

The  case  of  a  finance  bill 1  is  not  greatly  different  from 
that  of  a  bill  drawn  on  a  foreign  bank  which  expresses 
a  desire  to  lend.  There  is,  indeed,  a  difference,  but  it 
is  superficial  rather  than  fundamental.  In  the  case  of 
the  bill  drawn  on  a  foreign  lending  bank,  the  foreign 
bank  is  lending  as  an  investment  for  its  own  profit. 
In  the  case  of  the  finance  bill,  the  drawing  is  done  for 
the  convenience  and  profit  of  the  drawing  bank,  in  our 
illustration  the  American  bank.  In  this  case,  the  Eng¬ 
lish  bank  does  not  request  the  American  bank  to  draw 
on  it  to  the  end  that  the  English  bank  can  profit  by  so- 
called  lending.  On  the  contrary,  the  American  bank 
gets  the  permission  of  the  English  bank  to  draw  a  draft 
on  the  latter.  For  in  the  case  of  the  finance  bill  the  Eng¬ 
lish  bank  is  under  no  obligation  to  the  American  bank. 
The  latter,  therefore,  has  no  right  to  draw  a  draft  on  the 
former  except  by  permission.  Arrangement  is  accord¬ 
ingly  made  between  the  banks.  The  American  bank, 
Ba,  is  given  the  right  to  draw  on  the  English  bank,  Be, 
in  return  for  a  fee  or  commission.  Ba  then  draws  on 
Be,  sells  the  draft  in  the  market,  and,  for  the  time  being, 
e.g.  90  days,  has  the  use  of  so  much  extra  currency. 

1  Escher,  Elements  of  Foreign  Exchange,  pp.  94-98,  gives  a  brief  description 
of  the  finance  bill. 


THE  RATE  OF  EXCHANGE 


9i 


Ba’s  credit  is  good  enough  so  that  Be  is  willing  to  “accept  ” 
the  draft  or  drafts,  in  confidence  that  when  the  90  days 
after  sight  are  up,  and  payment  is  demanded,  it  will 
already  have  received  remittance  from  Ba.  It  will  at 
no  time  be  out  any  money.  The  finance  bill  is  therefore 
not  greatly  unlike  the  class  of  bills  previously  described, 
drawn  on  foreign  lending  banks. 

As  in  the  case  of  the  lending  operation,  so  in  the  case 
of  the  finance  bill  above  discussed,  some  American  (or 
Americans),  is  borrowing  from  abroad.  In  the  case 
of  the  finance  bill,  the  borrower  is  the  American  bank 
which  gets  the  90-day  control  of  currency,  and,  through 
the  bank,  any  person  or  persons  who  are  thus  enabled 
to  borrow  from  it.  Here,  as  before,  the  real  lender  is 
the  person,  or  firm,  in  England,  who  purchases  the  draft 
in  London,  whither  it  has  been  sent  for  sale  in  the  dis¬ 
count  market,  and  through  him  the  depositors  in  the 
English  bank  or  banks,  whose  convenience  waiting  gave 
him  the  means  to  invest  in  the  draft.  Ba  owes  Be,  but  Be 
owes  this  holder  of  its  draft,  and  he,  in  turn,  is  indebted, 
through  a  bank  as  intermediary,  to  the  depositors  of 
that  bank,  whose  convenience  waiting  provided  him 
with  the  means  of  purchase. 

Like  the  short-term  loan  operation,  the  finance  bill  — 
also  really  a  loan  from  abroad  —  may  serve  to  tide  over 
a  period  of  surplus  imports,  so  that  gold  need  not  so 
largely  be  shipped  out  at  one  season  of  the  year  only 
to  be  shipped  back  again  in  a  couple  of  months.  If, 
in  the  spring  and  early  summer,  when  we  are  perhaps 
importing  largely  and  exporting  less,  and  have,  there¬ 
fore,  a  surplus  indebtedness,  our  banks  are  allowed  to 
draw  finance  bills,  these  drafts  come  into  the  market 
and  are  available  for  use  in  paying  off  part  of  the  balance 


92  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


of  obligations.  We  therefore  pay  previous  obligations 
by  making  new  ones.  Considered  as  a  nation,  we  post¬ 
pone  payment ;  for  what  one  group  of  persons  pays, 
another  group  has  borrowed.  Then,  in  the  fall,  when 
there  would  otherwise  be  a  balance  of  obligations  from 
others  to  us,  this  balance  is  diminished  by  our  postponed 
obligations  to  them.  Not  only,  then,  are  there  smaller 
shipments  of  gold  abroad  in  the  earlier  period,  but  also 
there  are  smaller  return  shipments  at  the  later.1 

It  needs,  however,  to  be  demonstrated  that  finance 
bills  will  most  probably  be  drawn  by  American  banks 
at  those  times  when  we  have  a  balance  of  obligations  to 
meet,  thus  relieving  the  pressure,  and  serving,  as  above 
suggested,  to  obviate  the  necessity  of  gold  shipments. 
The  theory  of  individualism,  as  distinguished  from  so¬ 
cialism,  is,  that  in  serving  their  own  interest,  men  are, 
in  their  economic  activities  (except  where  certain  un¬ 
fair  methods  of  business  are  improperly  permitted,  or 
certain  classes  of  wealth  or  income  not  really  earned  are 
unwisely  secured  to  individuals),  serving  the  public 
interest.  Let  us  see  how  the  individualistic  philosophy 
applies  in  this  case.  In  that  part  of  the  year  when  the 
United  States  owes  largely,  the  price  in  the  United 
States  of  exchange  on  foreign  countries,  is  high.  It 
pays  Ba,  therefore,  to  draw  finance  bills,  and  sell  them 
at  this  high  price.2  On  the  other  hand,  the  excess  of 
obligations  towards  us  in  the  fall,  and  the  consequent 
excess  of  drafts  on  foreign  debtors,  for  sale  here,  makes 
the  price  of  these  drafts  at  that  time  low.  Ba  can  there¬ 
fore  buy  drafts  to  repay,  at  a  low  price.  If  necessary, 


1  Goschen,  The  Theory  of  the  Foreign  Exchanges,  pp.  38-41 ;  also  Bastable, 
The  Theory  of  International  Trade,  fourth  edition,  London  (Macmillan),  1903,  p.  78. 

2  Or  itself  forward  them  for  discount  and  credit  abroad. 


THE  RATE  OF  EXCHANGE 


93 


the  loan  can  be  renewed  by  the  drawing  of  a  new  draft 
to  replace  the  old,  in  cases  where  it  is  some  time  before 
the  rate  falls.  Ba  therefore  profits,  besides  the  interest 
which  can  be  earned  during  the  time  it  can  invest  or 
loan  the  amount,  by  the  difference  between  the  price 
of  the  drafts  at  one  time  and  another,  minus,  of  course, 
Be’s  commission.  Such  drafts  are,  therefore,  other 
things  being  equal,  most  likely  to  be  drawn  by  profit- 
seeking  banks  at  the  very  times  when  they  will  serve 
the  purpose  of  avoiding  gold  shipments.1 

§  6 

How  a  Bank  in  One  Country  and  a  Bank  in  Another  May , 
through  the  Aid  of  the  Exchange  Market,  Invest  in 
One  of  the  Countries  for  Joint  Account ,  without  Either 
Bank  Using  its  Own  Funds 

Another  variety  of  this  species  of  draft  is  that  some¬ 
times  drawn  when  an  American  and  a  foreign  bank  in¬ 
vest  here  on  joint  account.2  Ba  may  see  that  it  can  pur¬ 
chase  certain  securities  cheaply  at  the  time,  securities 
which  can  probably  be  sold,  later,  at  a  substantial 
profit.  But  Ba  has  use  for  all  the  funds  under  its  own 
immediate  control,  and  does  not  wish  to  invest  any  of 
these  funds  in  such  securities.  It  suggests,  therefore, 
to  its  English  correspondent,  Be,  that  both  go  into  this 
investment,  on  joint  account,  securing  the  means  through 
the  use  of  exchange.  Ba  then  draws  on  Be  a  draft  matur¬ 
ing  in  say  90  days  after  sight,  which  is  sold  in  New  York. 
With  the  proceeds  the  securities  are  purchased  and  held 

1  Cf.  Clare,  The  A.B.C.  of  the  Foreign  Exchanges ,  1893,  p.  86;  also  Escher, 
Elements  of  Foreign  Exchange,  p.  97,  and  Margraff,  International  Exchange , 
Chicago  (The  Fergus  Printing  Co.),  1903,  p.  39. 

2  Process  described  in  Escher,  Elements  of  Foreign  Exchange,  pp.  133-135. 


94  THE  EXCHANGE  MECHANISM  OF  COMMERCE 

for  90  days  or  perhaps  a  less  period.  They  are  then  sold, 
presumably  at  a  profit,  and  remittance  is  made  to  Bc. 
The  draft  on  Be  was  purchased  in  New  York,  sent  to 
London,  and  sold  in  the  London  discount  market.  By 
the  time  the  purchaser  presents  it  to  Be  for  payment, 
Ba  has  remitted.  Neither  bank  has  sacrificed  the  use 
of  its  own  funds.  As  in  the  other  cases,  the  capital  is 
really  furnished,  in  the  last  analysis,  by  the  purchaser, 
in  the  London  discount  market,  who  has  bought  the 
draft,  or,  in  all  probability,  by  the  depositors  of  a  bank 
from  which  the  purchaser  borrowed  the  means  to  make 
the  investment.  Thus  it  is  that  an  American  and  an 
English  bank  can  invest  here,  for  joint  account,  in  securi¬ 
ties,  without  either  of  them  providing  the  means.  The 
capital  is  really  put  up  by  an  Englishman  or  Englishmen, 
but  not  by  the  English  bank  on  which  the  bill  is  drawn. 
As  in  the  case  of  lending  by  a  foreign  bank  and  the  case 
of  the  finance  bill,  so  here,  there  would  be  some  addi¬ 
tional  stimulus,  other  things  equal,  to  the  drawing  of 
such  drafts  on  foreign  banks  at  those  times  of  the  year 
when  drawing  them  would  decrease  the  shipments  of 
gold. 

§  7 

Analysis  of  the  Relations  Involved  in  a  Letter  of  Credit 

The  exportation  and  the  importation  of  goods  may 
often  be  greatly  facilitated  by  so-called  letters  of  credit.1 
These  letters  of  credit  make  possible  the  drawing  of 
bills  of  exchange  on  other  parties  than  the  actual  debtors, 
and  at  times  such  an  arrangement  is  very  helpful.  As 
above  suggested,  this  form  of  commercial  credit  may  be 
used  to  further  either  import  or  export  trade.  Since 

1  Described  by  Escher,  Elements  of  Foreign  Exchange ,  pp.  143-160. 


THE  RATE  OF  EXCHANGE 


95 


it  will  facilitate  importation  and  since  exportation  by  us 
is  importation  by  some  other  country,  it  must  facilitate 
exportation  also. 

The  use  of  a  letter  of  credit  is  as  follows.  A  man 
importing  goods,  say  from  South  Africa  into  the  United 
States,  desires  to  get  possession  of  them  at  once,  but  is 
not  in  a  position  to  pay  for  them  until  he  can  himself 
dispose  of  them  for  currency.  He  cannot,  therefore, 
pay  for  them  by  remitting  a  bank  draft.  On  the  other 
hand,  the  South  African  exporter  desires  to  receive  his 
pay  immediately.  The  American  importer  goes  to  his 
bank,  say  Ba,  and  asks  for  a  letter  of  credit.  If  the 
circumstances  warrant  it,  Ba  issues  such  a  letter,  which 
is  in  the  form  of  a  request  on  Be,  the  London  corre¬ 
spondent  of  Ba,  to  accept,  up  to  a  given  amount  and 
under  specified  conditions,  the  drafts  of  the  South 
African  exporter.  The  London  bank  is  informed  that 
such  a  request  on  it  has  been  issued  to  the  importer. 
The  American  importer  sends  this  letter  to  South  Africa, 
and  the  exporter  there  is  then  in  a  position  to  draw  a 
draft  on  the  London  bank,  Be,  instead  of  on  the  Ameri¬ 
can  importer  or  his  bank,  Ba.  If  the  draft  is  drawn  for 
90  days  after  sight,  the  American  importer  has  that 
length  of  time  to  settle.  The  goods  are  billed  to  his 
bank,  Ba,  which  issued  the  letter  of  credit;  and  the 
bank  will  probably  let  him  take  over  the  goods  upon  his 
signing  a  trust  receipt  securing  the  bank.  The  draft 
drawn  in  South  Africa  is  sent  to  London,  presented, 
“  accepted,”  and  sold  in  the  discount  market.  The  bill 
of  lading  and  insurance  certificate  were  attached  to  the 
draft  to  begin  with,  but  when  the  latter  is  “ accepted” 
the  London  bank  detaches  all  documents  and  sends 
them  to  the  New  York  bank  so  that  the  goods  may  be 


96  THE  EXCHANGE  MECHANISM  OF  COMMERCE 

secured  upon  arrival.  By  the  time  the  draft  is  due  the 
American  importer  has  paid  his  bank  and  it  has  settled 
with  the  London  bank.  This  then  is  another  illustra¬ 
tion  of  borrowing  by  a  business  man  or  business  men  in 
the  United  States,  the  real  lender  or  creditor  being  the 
purchaser  of  the  draft,  in  the  London  discount  market, 
and  through  him  the  depositors  in  some  Fngikh  bank. 

One  of  the  chief  reasons,  in  fact,  for  the  use  of  a  letter 
of  credit,  is  to  enable  the  exporter  to  draw  on  London 
or  some  other  well-known  banking  centre.  His  draft 
will  then  bring  the  highest  possible  price.  London, 
as  the  principal  banking  and  exchange  centre  of  the 
world  and  a  great  exchange  discount  market,  is  most 
frequently  the  place  drawn  on.  The  exporter  can  get 
immediate  payment 1  and  the  importer  can  get  credit. 


Place  Speculation  or  Arbitr aging  in  Exchange 

Just  as  there  may  be  place  speculation  and  time  specu¬ 
lation  in  the  case  of  commodities,  so  both  of  these  types 
of  speculation,  or  something  analogous  to  them,  exist 
in  the  case  of  drafts.  Corn  may  be  sent  from  a  place 
where  it  is  relatively  cheap  to  a  place  where  it  is  rela¬ 
tively  dear. .  This  is  arbitraging  in  corn.  Similarly 
there  is  arbitraging  in  exchange.2  Arbitraging  in  ex¬ 
change  involves  the  purchase  of  drafts  on  one  place  and 
the  sale  of  drafts  on  another.  Thus,  if  in  New  York 
exchange  on  London  is  high  while  exchange  on  Paris  is 


menf  f  l  6  r>°  15  confirmed”  the  bank  made  drawee,  then  pay- 

ment  is  absolutely  guaranteed  to  the  exporter,  even  before  his  bill  is  “accepted^’ 

^ee  Margraff,  International  Exchange,  Chicago  (Fergus  Printing  Co.),  1903,  pp. 
2  Described  in  Escher,  Elements  of  Foreign  Exchange,  pp.  98-101. 


THE  RATE  OF  EXCHANGE 


97 


low ;  and  if  in  Paris,  exchange  on  London  is  fairly  low, 
an  arbitraging  transaction  would  be  profitable.  The 
arbitrager  in  New  York  would  buy  exchange  on  Paris, 
would  instruct  his  Paris  correspondent  to  buy  exchange 
on  London,  and  would  then  be  able  to  sell  in  New  York, 
exchange  on  London.  Thus  the  cheaper  exchange  on 
London,  available  in  Paris,  is  shifted  to  New  York. 
Exchange  on  London  is  sold  from  Paris  where  it  is  cheap, 
to  New  York  where  it  is  dear.  This  activity  by  arbi¬ 
tragers,  of  course,  tends  to  limit  the  variations  in  price 
at  different  places,  of  exchange  on  any  one  point.  It 
is  seldom  possible  to  make  a  very  considerable  per  cent 
gain  by  such  transactions. 


§  9 


Time  Speculation  in  Exchange 

Besides  arbitraging  or  place  speculation,  there  is 
also  time  speculation  in  exchange.  As  with  produce, 
e.g.  wheat,  this  speculation  in  time  may  be  speculative 
holding,  buying  and  selling  of  futures,  and  (a  part  of 
future  selling)  selling  short.  Suppose  a  New  York  bank 
to  purchase  bills  of  exchange  on  London  and  to  send 
them  over  for  discount  ( i.e .  sale),  either  for  immediate 
discount  or  for  discount  as  occasion  requires.  The 
New  York  bank  is  then  accumulating  in  England  a  basis 
for  its  own  drafts.1  If,  at  the  time,  bills  of  exchange 
on  England  are  purchasable  at  a  low  price,  the  New 
York  bank  will  be  more  likely  to  buy,  and  later,  when 
exchange  is  higher,  it  will  be  under  greater  temptation 
to  sell.  If  the  New  York  bank  buys  exchange  when  the 


1  Cf.  Clare,  The  A.B.C.  of  the  Foreign  Exchanges,  p.  87 ;  and  Escher,  Elements 
of  Foreign  Exchange,  p.  30. 


98  THE  EXCHANGE  MECHANISM  OF  COMMERCE 

rate  is  low,  then  its  buying  tends  to  keep  up  the  rate, 
and  when  it  later  sells,  at  relatively  high  prices,  its  sell¬ 
ing  tends  to  keep  the  rate  down.  This  kind  of  trans¬ 
action,  therefore,  acts  on  the  exchange  market  just  as 
speculative  holding  of  wheat  acts  on  the  wheat  market, 
namely  in  the  direction  of  equalization.  Such  specula¬ 
tive  holding  of  exchange,  in  so  far  as  it  exists,  serves  to 
decrease  the  alternate  import  and  export  of  gold.  When 
exchange  here,  on  England,  is  low  because  of  the  excess 
of  obligations  from  them  to  us,  a  part  of  this  excess  of 
obligations  may  take  the  form  of  available  credit  for 
American  banks  with  English  banks.  So  much,  there¬ 
fore,  of  the  excess  of  obligations,  need  not  be  settled  by 
the  shipment  of  gold.  Later,  when  gold  tends  to  flow 
from  the  United  States  to  England,  this  accumulated 
credit  in  England  obviates  the  necessity  of  so  great  a 
flow  of  gold  as  would  else  occur.  We  may  say  that, 
since  part  of  the  money  which  was  collectible  by  Ameri¬ 
can  banks  (though  perhaps  collectible  only  through 
the  London  discount  market),  is  allowed  to  remain  as 
a  credit  in  England,  either  as  bank  credit  or  as  long  bills 
not  discounted  but  held  for  account  of  American  banks,1 
the  later  obligations  to  England  are  paid  partly  by  draw¬ 
ing  on  that  credit  instead  of  shipping  gold. 

There  is  also  the  buying  and  selling  of  futures  in 
exchange.  To  illustrate,  an  exporter  may  know  long 
in  advance  that  he  is  to  ship  goods  of  a  certain  value 
at  a  given  time.  He  will  then  be  able  to  draw  a  draft 
on  the  purchaser  of  these  goods.  But  if  he  waits  until 
he  has  sold  the  goods  before  making  any  arrangements 
regarding  his  draft,  he  simply  takes  the  risk  of  selling 

For  further  explanation  of  the  nature  and  method  of  these  transactions  see 
Cb.  VI  (of  Part  I),  §  2. 


THE  RATE  OF  EXCHANGE 


99 


the  draft  on  his  debtor  for  whatever  is  the  ruling  price 
at  the  time  of  the  sale.  He  can,  however,  contract 
ahead  for  the  disposal  of  his  draft  to  some  exchange 
dealer  or  banker,  at  an  agreed  price.1  He  is  selling  or 
agreeing  to  sell  future  exchange. 

Sometimes  a  bank  remits  drafts  to  its  foreign  corre¬ 
spondent,  some  of  which,  being  payment  bills,  cannot 
be  immediately  discounted  for  cash.2  These  bills  will, 
of  course,  with  few  if  any  exceptions,  eventually  be  paid ; 
and  if  there  are  very  many  of  them,  then  the  remitting 
bank  can  estimate,  because  of  the  constancy  of  averages, 
at  about  what  dates  they  will  be  paid.  This  bank  is 
therefore  in  a  position  to  promise  that  it  will  sell  demand 
drafts  on  its  correspondent  abroad,  at  given  dates  and 
for  given  amounts.  It  promises  to  sell  these  drafts 
at  some  future  time  when  it  can  be  sure  of  having  the 
balance  abroad  on  which  to  draw.3  In  this  case  the 
future  selling  is  done  by  a  bank.  By  making  such  an 
arrangement,  the  bank  guards  itself  against  the  risk 
of  unfavorable  exchange  rate  fluctuations.  By  selling 
futures  against  futures  a  bank  can  relieve  itself  entirely 
from  risk  of  such  fluctuations.  The  bank  buys  or  con¬ 
tracts  to  buy,  an  exporter’s  future  bills,  and  at  the  same 
time  sells  or  contracts  to  sell,  its  own. 

As  in  other  dealing,  so  in  foreign  exchange,  one  kind 
of  “ future”  selling  is  selling  “short.”  To  sell  “short” 
is  to  agree  to  sell  at  a  future  time,  without  having,  at 
the  time  of  making  the  agreement,  the  means  to  deliver, 
but  relying  upon  later  purchases  to  “cover”  the  shortage. 
A  man  sells  wheat  short  if  he  contracts,  say  in  March, 


1  See  Escher,  Elements  of  Foreign  Exchange,  p.  35. 

*  See  Ch.  Ill  (of  Part  I),  §  7. 

*  Escher,  Elements  of  Foreign  Exchange,  p.  101. 


ioo  THE  EXCHANGE  MECHANISM  OF  COMMERCE 

to  sell  for  May  delivery,  counting  on  his  ability  to  pur¬ 
chase  the  wheat  in  May,  in  order  to  make  good  the  agree¬ 
ment.  Similarly  an  exchange  dealer  sells  short  if  he 
agrees  to  sell  a  draft,  e.g.  in  June  for  August  delivery, 
but  has,  when  the  contract  is  made,  no  bank  balance 
abroad  or  salable  drafts  held  in  his  name  in  some  foreign 
bank,  on  which  he  may  draw.  He  relies  upon  August 
purchases  of  bills  to  provide  this  foreign  balance.  The 
same  in  principle  as  short  selling  is  the  finance  bill  al¬ 
ready  described,  and  other  similar  bills.  In  the  case  of 
the  finance  bill,  one  bank  does  not  merely  promise  to 
sell  at  a  future  time ;  it  actually  does  sell,  in  the  present, 
a  draft  on  another  bank  where  it  has  at  the  time  no 
credit  balance  and  no  deposit  of  discountable  bills. 
This  draft,  though  sold  in  the  present,  is  of  course  for 
future  payment.  It  is  a  draft  for  60  or  90  days  or  for 
some  other  period.  It  requires  to  be  “  covered  ”  before 
maturity.  Hence  it  may  properly  be  classed  with  or 
alongside  of  other  short  selling. 

§  10 

Summary 

The  starting  point  of  our  discussion  of  the  rate  of 
exchange  has  been  supply  and  demand.  At  any  given 
time  the  price,  say  in  New  York,  of  drafts  on  London, 
i.e.  the  rate  of  exchange  on  London,  is  fixed  where  supply 
of  and  demand  for  such  exchange  are  equal.  Thus, 
exchange  may  go  above  or  below  par,  the  mint  equiva¬ 
lent  in  coinage. 

Going  back  of  supply  and  demand,  we  found  that 
these  depend  upon  purchases  and  sales,  investments, 
interest  and  dividends,  etc.  Whatever  tends  to  increase 


THE  RATE  OF  EXCHANGE 


IOI 


the  total  payments  to  be  made  by  Americans  to  English¬ 
men  tends  to  increase  the  demand  here  for  drafts  on 
England.  Vice  versa,  whatever  increases  the  total 
payments  to  be  made  from  them  to  us  increases  the 
supply  here  of  drafts  on  England  (or  decreases  the  de¬ 
mand). 

Analysis  of  the  short  time  loan  by  a  foreign  bank,  of 
the  so-called  finance  bill,  and  of  investment  here  by  an 
American  and  a  foreign  bank  for  joint  account,  led  to 
the  conclusion  that  in  all  cases  the  borrower  was  the 
business  firm  here  which  profited  by  the  loan,  while  the 
ultimate  lender  was  the  person  in  the  London  or  other 
discount  market  who  bought  the  bill  and  held  it  till 
maturity,  or  the  depositors  of  the  bank  from  which  such 
a  buyer  obtained  the  means  of  purchase.  In  the  case 
of  some  of  these  bills,  most  of  all,  perhaps,  the  finance 
bill,  there  is  probably  a  tendency  for  more  to  be  sold, 
other  things  equal,  at  those  times  of  year  when  gold 
must  otherwise  be  more  largely  exported;  and  to  be 
redeemed,  later,  when  gold  must  otherwise  be  more 
largely  imported.  The  letter  of  credit  is  a  scheme  to 
get  immediate  payment  for  an  exporter,  a  period  of 
credit  for  an  importer,  and  a  chance  for  the  exporter 
to  make  out  a  draft  on  an  important  financial  centre  and 
therefore  a  more  salable  draft  than  he  might  else  have. 
As  with  the  finance  bill,  short  time  loan,  etc.,  the  credit 
is  really  furnished  by  investors  or  by  bank  depositors 
in  the  discount  market  of  the  big  banking  centre,  most 
likely  London,  where  the  draft  is  sold. 

Exchange  is  speculated  in,  much  as  are  wheat,  corn, 
stocks,  etc.  There  may  be  arbitraging  in  exchange,  i.e. 
sending  exchange  on  some  point,  from  where  it  is  rela¬ 
tively  cheap  to  where  it  is  relatively  dear.  Exchange 


xo2  THE  EXCHANGE  MECHANISM  OF  COMMERCE 

may  be,  in  a  sense,  held  for  a  rise,  thus  tending  to  steady 
the  exchange  market  and  decrease  the  flow  of  specie; 
it  is  subject  to  “ future”  dealings;  it  is  sold  “short.” 
The  finance  bill  is  really,  in  principle,  a  kind  of  short  sell¬ 
ing  of  exchange.  An  agreement  to  sell  at  some  future 
date,  relying  upon  purchases  of  exchange  in  the  mean¬ 
while,  to  cover,  is  clearly  selling  short. 


CHAPTER  V 


The  Rate  of  Exchange  and  the  Flow  of  Specie 


The  Upper  Limit  to  Fluctuation  of  the  Rate  of  Exchange , 
Determined  by  the  Cost  of  Exporting  Specie 

We  have  seen  that,  by  the  use  of  finance  bills  and  other 
similar  arrangements,  the  excessive  obligations  of  a 
country  to  other  countries  during  any  short  period  may 
be  in  part  balanced  by  the  reverse  obligations  of  a  later 
period.  We  have  also  seen  that,  by  speculative  holding 
(accumulation)  of  exchange,  the  surplus  obligations  to  a 
country  during  an  earlier  period  may  be  used  to  offset, 
in  part,  the  obligations  incurred  by  it  in  a  later.  But 
sometimes  there  will  be  a  net  balance  of  obligations  in  one 
direction  for  several  months  or  a  year  or  a  series  of  years. 
If  so,  the  obligations  probably  will  not  be  liquidated  for 
the  most  part  by  postponement  or  by  exchange  accumu¬ 
lation.  The  demand  for  bills  with  which  to  meet  a  long 
continued  balance  of  indebtedness  will  hardly  be  satisfied 
by  the  sale  of  finance  bills  or  other  bills  of  similar  nature, 
for  the  bankers  of  a  country  cannot  be  indefinitely  add¬ 
ing  to  their  obligations  of  this  sort  and  not  repaying. 
Neither  will  the  supply  of  bills  caused  by  a  long  continued 
excess  of  obligations  to  a  country  be  taken  care  of  by 
speculative  purchase  and  holding  for  a  rise,  since  there  is 
a  limit  to  the  amount  which  bankers  can  afford  to  invest 
in  such  speculative  holding.  If,  therefore,  our  obliga- 

103 


io4  THE  EXCHANGE  MECHANISM  OF  COMMERCE 

tions  are  larger  for  any  great  length  of  time  than  the 
obligations  to  us,  there  will  be  a  great  demand  for  bills  of 
exchange  with  which  to  remit  and  there  will  be  a  relative 
scarcity  of  such  bills.  Consequently,  the  price  of  bills 
or  the  rate  of  exchange  on  other  countries,  which  will 
equalize  supply  and  demand,  must  maintain  a  fairly  high 
average.  On  the  other  hand,  if  obligations  to  us  are  for 
a  long  period  in  excess,  the  rate  of  exchange  here,  on 
foreign  countries,  must  be  fairly  low,  else  the  supply  of 
drafts  on  these  countries  will  exceed  the  demand. 

Are  there  any  limits,  upper  and  lower,  to  the  rate 
exchange  may  reach  ?  Are  there  any  limits,  for  instance, 
upper  and  lower,  to  the  price  that  drafts  on  London  may 
command  in  New  York?  If  there  are,  what  forces 
determine  these  limits  ? 

Let  us  consider,  first,  the  question  of  an  upper  limit  of 
exchange.  The  price  in  the  United  States,  of  drafts  on 
England,  will  not  go  above  par  by  much  more  than  the 
cost  of  shipping  specie.  For  if  it  does  so,  either  the 
demand  for  such  drafts  will  decrease,  or  the  supply  will 
increase,  or  both,  to  such  an  extent  that  supply  will 
exceed  demand.  A  rise  of  exchange  above  par  by  more 
than  the  cost  of  specie  shipment  must  decrease  the 
demand  for  drafts,  because  many  of  those  in  this  country 
who  are  debtors  will,  if  their  debts  are  large,  find  it 
cheaper  to  ship  specie  than  to  buy  drafts.  It  is  true  that 
in  some  cases  the  debts  of  merchants,  etc.,  are  settled 
by  their  English  creditors  drawing  on  them.  But  if 
so,  the  bills  drawn  on  these  Americans  have  to  be  sent 
to  American  banks  for  collection  and  these  American 
banks  must  then  settle  with  the  English  banks  sending 
the  drafts.  And  if  the  rate  of  exchange  goes  above  par 
by  more  than  the  cost  of  shipping  gold,  American  banks 


RATE  OF  EXCHANGE  AND  FLOW  OF  SPECIE  105 


having  large  remittances  to  make  will  prefer  to  ship  gold 
rather  than  to  buy  for  shipment  the  more  expensive  bills 
of  exchange.  As  a  matter  of  fact,  merchants,  manu¬ 
facturers,  etc.,  will  rarely  have  the  facilities  and  knowl¬ 
edge  or  the  large  indebtedness  to  warrant  their  shipping 
gold,  and  will  continue  to  send  drafts.  But  debtor  banks 
frequently  do  ship  gold.  We  may  say,  then,  that  at  a 
rate  of  exchange  much  farther  above  par  than  the  cost 
of  shipping  specie,  the  demand  here  for  drafts  on  Eng¬ 
land  (and  other  foreign  countries)  would  fall  short  of  the 
supply.  Therefore,  such  a  rate  could  not  continue. 

We  arrive  at  the  same  conclusion  from  a  study  of  the 
supply  side  of  the  market.  If  the  rate  of  exchange,  i.e. 
the  price  of  drafts,  rises  above  par  by  more  than  the  cost 
of  specie  shipment,  then  it  will  pay  some  banks,  even 
though  they  owe  nothing,  to  export  gold.  The  gold  will 
be  exported  to  a  consignee,  say  a  foreign  correspondent 
bank  in  London.  Then  the  American  bank  can  count 
on  having  a  balance  or  drawing  account  in  the  London 
bank,  in  the  same  manner  as  if  drafts  had  been  sent. 
On  this  balance,  the  American  bank  can  draw  its  own 
drafts  for  sale  in  the  United  States,  at  the  high  ruling  rate, 
to  persons  having  remittances  to  make.  By  so  doing, 
the  bank  adds  to  the  supply,  here,  of  drafts  on  England, 
and  the  ordinary  business  man  has  no  occasion,  himself, 
to  ship  gold.  So  a  rise  in  the  price  of  drafts  on  England, 
beyond  a  certain  point,  will  tend  to  increase  the  supply 
of  such  drafts.  And  at  a  price  which  exceeds  par  by  much 
more  than  the  cost  of  shipping  specie,  supply  would  al¬ 
most  necessarily  exceed  demand,  because  the  shipment 
of  specie  on  which  to  sell  drafts  would  be  so  profitable. 
It  follows  that  the  rate  of  exchange  cannot,  ordinarily, 
be  expected  to  exceed  par  by  much  more  than  the  gold 


106  THE  EXCHANGE  MECHANISM  OF  COMMERCE 

shipment  cost.  It  is  kept  down  by  forces  on  the  supply 

side  of  the  market,  as  well  as  by  forces  on  the  demand 
side. 

We  may  fairly  assume  the  cost  of  gold  shipment 
between  New  York  and  London  to  be,  for  large  quanti¬ 
ties,  about  $2  per  £100,  including  charge  for  transporta¬ 
tion,  insurance,  and  all  other  expenses.  Then,  since  par 
between  New  York  and  London  is  $486.65  =  £100,  the 
price  in  New  York  of  sight  drafts  on  London  could  not 
much  exceed  $488.65  =  £100.  So  soon  as  it  gets  as 
high  as  that  or  higher,  it  becomes  as  cheap  or  cheaper  for 
New  York  banks  to  settle  their  indebtedness  to  English 
banks  by  purchasing  and  shipping  gold  as  by  purchasing 
and  shipping  drafts.  A  draft  on  London  for  £100  would 
cost,  if  exchange  were  at  its  highest  point,  $488.65  or 
more.  But  if  $486.65  in  gold  could  be  shipped  to  London 
for  $2,  making  a  total  expense  of  $488.65,  no  New  York 
bank,  having  a  remittance  to  make,  would  pay  a  higher 
price  for  a  draft.  Hence  the  demand  for  drafts  on  Eng¬ 
land  must  fall.  Likewise,  so  soon  as  exchange  gets 
higher  than  $488.65  =  £100,  it  becomes  profitable  for 
New  York  banks  to  purchase  gold,  ship  it  abroad,  and 
sell  drafts  drawn  on  the  credit  so  secured.  $486.65  in 
gold  plus  $2  for  shipment,  loss  of  interest,  insurance,  etc., 
makes  $488.65,  total  expense.  The  $486.65  is  worth  in 
England,  mint  equivalent,  £100.  If  a  draft  on  the 
English  consignee  for  £100  will  sell  for  more  than 
$488.65,  it  is  obviously  profitable  to  ship  gold  and  sell 
drafts.  To  ship  drafts  instead  of  gold  might  be  less 
profitable,  because  of  their  high  price.  Because  of  gold 

shipments,  the  supply  of  drafts  on  England  must  be 
greater. 

The  cost  of  gold  shipment,  however,  may,  under  the 


I 


RATE  OF  EXCHANGE  AND  FLOW  OF  SPECIE  107 

pressure  of  special  circumstances*  go  far  above  $2  per 
£100;  and  this  cost  is,  therefore,  a  somewhat  elastic 
rather  than  a  definitely  rigid  limit  to  the  possible  rise 
of  exchange.  For  example,  the  prospect  of  a  great  Eu¬ 
ropean  war  caused  insurance  rates  on  gold  shipments  to 
Europe  to  rise  as  high  as  1  per  cent  on  July  30  and  31 
of  this  year  (1914) }  Such  charges,  nearly  $5  per  £100 
for  insurance  alone,  at  a  time  when  there  was  a  strong 
movement  in  foreign  countries  to  sell  securities  and  real¬ 
ize  gold,  and  when,  consequently,  the  United  States  was 
exporting  gold,  made  possible  a  rise  in  exchange  rates 
much  above  the  usual  upper  limit.  In  fact,  the  foreign 
exchange  market  seems  to  have  been,  in  this  case,  com¬ 
pletely  demoralized  by  the  suddenness  of  the  crisis.2 
The  immediately  ensuing  outbreak  of  war  on  an  extended 
scale  brought  a  sudden  check  to  trade  in  general,  in¬ 
cluding  the  export  of  gold.  One  vessel,  the  Kronprin- 
zessin  Cecilie  of  the  North  German  Lloyd  Company, 
which  had  left  New  York  July  28  carrying  over 
$10,000,000  in  gold  and  silver  consigned  to  English  and 
French  banking  houses,  returned  with  her  cargo  to  the 
United  States  (Bar  Harbor,  Me.,  Aug.  4)  rather  than 
risk  capture.3 

§  2 

Some  Details  Connected  with  the  Exportation  of  Specie 

A  number  of  details  of  the  gold  export  operation  may 
now  claim  our  attention.  Let  us  consider  first  the  loss 
of  interest  during  transportation  of  the  gold.  If  it  takes 
seven  days  to  transport  the  gold  and  if  the  draft  drawn 
upon  it  is  sold  when  the  gold  is  shipped  and  goes  abroad 

1  See  New  York  World,  July  31  and  Aug.  1,  1914. 

1  Ibid.,  July  31,  1914. 

•  New  Haven  Evening  Register,  Aug.  4,  1914. 


108  THE  EXCHANGE  MECHANISM  OF  COMMERCE 

at  about  the  same  time,  this  draft  can  hardly  be  honored  in 
less  than  seven  days.  The  purchaser  of  the  draft,  there¬ 
fore,  must  pay  for  it  seven  days  before  his  foreign  creditor 
can  receive  the  money,  and  so  must  lose  seven  days  inter¬ 
est.  The  alternative  to  such  a  purchase  would  be  to 
wait  seven  days  and  buy  a  cable.  If  he  buys  the  banker’s 
draft  on  the  gold  he  will,  presumably,  pay  very  slightly 
less  for  it  in  consequence  of  this  period  of  waiting. 
Accordingly,  the  price  received  by  the  drawing  bank  is 
very  slightly  less.  Any  demand  draft,  however,  other 
than  a  cable,  must  suffer  such  a  deduction  for  interest. 
And  demand  drafts  drawn  when  goods  are  shipped  on 
the  consignees,  cannot  usually  be  cables,  since  the  con¬ 
signees  cannot  be  expected  to  pay  for  goods  before 
receiving  them.  Any  exporter,  then,  may  be  said  to  lose 
interest  in  the  same  way.  He  ships  goods  which  may  not 
reach  their  destination  for  several  days  or  weeks.  If  they 
arrive  on  the  same  steamer  as  his  draft  (which  is  at  once 
shipped  by  the  purchasing  American  bank),  the  draft 
may  be  made  payable  at  sight.  But  even  then  there  is 
time  lost.  Had  the  goods  been  sold  at  home,  this  loss 
need  not  have  occurred.  It  is  one  of  the  deductions  from 
t  e  benefits  of  trade  between  widely  separated  areas 
that  wealth  in  transit  is  temporarily  kept  out  of  use’ 
The  American  exporter  may  get  more  for  his  goods  if 
sold  m  England,  than  he  could  get  at  home,  and  the 
English  buyer  may  get  these  goods  more  cheaply  than  if 
he  purchased  them  in  his  own  country.  This  gain  to 
both  parties  will  presumably  exceed  all  losses,  including 
the  loss  of  time,  incident  to  handling  and  transporting 
die  goods.  Otherwise  the  trade  would  not  take  place. 

ut  the  cost  of  transportation  makes  the  net  gains  con¬ 
siderably  less  than  they  would  else  be,  and  the  loss  of 


RATE  OF  EXCHANGE  AND  FLOW  OF  SPECIE  109 


time  involved  makes  them  somewhat  less.  The  exporter 
of  any  goods,  then,  may  be  said  to  lose  something  in 
interest  when  he  sells  a  sight  draft  on  the  consignee, 
though  the  price  he  receives  for  the  goods  may  make  the 
transaction  well  worth  while.  The  gold  exporting  bank 
is  no  exception.  This  slight  loss,  however,  is  not  ordi¬ 
narily  reckoned  as  one  of  the  expenses  of  exporting  gold. 
The  banker  thinks  of  the  price  his  draft  brings,  as  his 
receipts,  and  does  not  regard  the  slight  reduction  below 
what  it  would  yield  if  collectible  at  once,  as  an  expense. 
Insurance  of  the  gold,  transportation  charges,  etc.,  are 
deductions,  along  with  the  cost  of  the  gold,  from  his  gross 
returns,  and  these  he  regards  as  his  expenses. 

When  gold  is  exported,  it  must  be  assayed,  weighed, 
etc.,  on  arrival,  and,  since  this  requires  some  three  days, 
there  must  be  subtracted  interest  for  that  time  from 
the  shipper’s  gross  profit.  If  the  draft  drawn  upon  the 
gold  is  a  sight  draft,  it  may  be  presented  and  paid  three 
days  before  the  gold  shipped  can  rightly  be  credited 
to  the  drawer.  If  so,  there  is  technically  an  “overdraft” 
on  which  interest  has  to  be  allowed  by  the  American  gold 
exporting  bank1  to  the  English  consignee  bank.  That 
is,  this  interest  must  be  deducted  from  the  balance  in 
England  on  which  the  American  bank  can  draw.  When 
the  American  bank  exports  gold  as  the  cheapest  means  of 
settling  a  debt,  there  is  the  same  loss  of  time,  and  so,  in 
a  sense,  loss  of  interest,  during  assaying,  weighing,  etc., 
as  well  as  during  transit. 

Still  another  detail  should  be  mentioned.  In  New 
York,  or  at  any  United  States  subtreasury,  gold  is  always 
purchasable  with  dollars  ( e.g .  United  States  notes,  gold 

1  See  Escher,  Elements  of  Foreign  Exchange ,  New  York  (The  Bankers  Publish¬ 
ing  Co.),  1911,  pp.  1 14,  115. 


no  THE  EXCHANGE  MECHANISM  OF  COMMERCE 

certificates  or  silver)  at  the  same  rate  or  price.  An 
ounce  of  pure  gold  is  always  worth  $20,671,  and  an  ounce 
of  gold  9/10  fine  is  worth  $18,604.  The  subtreasuries 
aim  to  have  bar  gold  available,  but  if  the  supply  is 
exhausted,  then  gold  coin  can  be  secured  for  export. 
There  is  no  question,  therefore,  here,  as  to  the  cost  of  the 
gold  to  be  shipped.  But  there  is  some  variation  in  the 
amount  of  coin  of  the  realm  which  the  specie  may  be 
worth  on  arrival  in  Great  Britain.  This  is  because, 
while  the  bank  of  England  is  by  law  compelled  to  pay 
£3  17*  9 d.  per  ounce  for  gold,  the  mint  equivalent  of 
an  ounce  is  £3  17 5.  10 \d.  Any  one  can  get  the  larger 
amount  for  his  gold  by  waiting  to  have  it  coined.  But 
on  account  of  the  delay  and  consequent  loss  of  interest 
while  the  gold  is  being  coined,  together  with  the  labor  of 
weighing  and  assaying,  the  bank  is  not  compelled  to  give 
the  mint  par  for  gold ;  though,  to  relieve  others  of  the 
necessity  of  waiting,  it  is  under  obligation  to  give  for 
it  the  somewhat  less  price  stated  above.  The  bank,  how¬ 
ever,  may  have  sufficient  use  for  gold,  for  reserve,  export 
or  other  purpose,  so  that  it  will  bid  the  full  mint  price  or 
even  more.  If  all  gold  coins  were  full  weight,  the  bank 
would  never  bid  more  than  the  mint  price,  since  coined 
gold  could  be  used  and  it  would  be  cheaper  to  use  coined 
gold  for  any  purpose  for  which  the  gold  bars  (or  bullion) 
might  be  desired,  than  to  pay  a  higher  price  for  the  latter. 
The  price  of  gold  would,  in  that  case,  fluctuate  between 
£3  175.  9 d.  and  £3  17 s.  10 %d.  In  fact,  it  may  and  some¬ 
times  does  go  slightly  above  the  latter  price,  because  the 
bank  may  be  purchasing  gold  with  worn  coins,  which, 
while  within  the  legal  limit  of  tolerance  in  England, 
would  have  to  pass  by  weight  if  exported.  The  American 
bank  which  exports  gold  to  England  cannot  tell,  there- 


RATE  OF  EXCHANGE  AND  FLOW  OF  SPECIE  hi 


fore,  just  what  it  will  be  worth  on  arrival  (though  doubt¬ 
less  some  one  could  be  found  to  guarantee  a  price). 
The  money  value  on  arrival  will  depend,  slightly,  on 
what  is  being  offered  for  gold  at  the  time. 

Sometimes  the  export  of  gold  involves  a  triangular 
operation.1  For  instance,  Ba  wishes  to  get  a  balance 
with  Be  in  England,  on  which  to  sell  drafts.  Drafts 
on  England,  here,  are  high,  and  Ba  does  not  wish  to  buy 
any  in  such  a  market.  But  it  may  happen  that  in  Paris, 
drafts  on  London  are  below  par.  The  high  rate  in  New 
York  of  drafts  on  Paris,  however,  tends  to  discourage 
arbitraging.  Instead,  Ba  can  ship  gold  to  its  Paris 
correspondent,  Bf,  and  order  the  Paris  bank  to  buy  a 
draft  on  London.  This  draft  is  sent  to  London  for  dis¬ 
count,  and  Ba  then  has  a  balance  in  London,  with  Be, 
on  which  it  can  draw  at  a  profit  above  cost. 

§  3 

The  Lower  Limit  to  Fluctuation  of  the  Rate  of  Exchange , 
Determined  by  the  Cost  of  Importing  Specie 

As  the  rate  of  exchange  has  an  upper  limit,  though  of 
course  a  slightly  elastic  one,  so  also  it  has  a  lower  limit. 
If  exchange  falls  below  par  by  much  more  than  the  cost 
of  importing  specie,  either  the  supply  of  drafts  on  foreign 
countries  must  decrease,  or  the  demand  for  such  drafts 
must  increase,  or  both,  to  such  an  extent  that  sup¬ 
ply  exceeds  demand.  The  supply  of  drafts  on  foreign 
countries  would  tend  to  decrease,  because  those  having 
collectible  debts  abroad  in  any  considerable  quantities, 
on  which  they  desired  to  realize,  would  find  it  cheaper 
to  pay  for  the  importation  of  specie  than  to  sell  at  so  great 


1  See  Escher.  Elements  of  Foreign  Exchange,  p.  1 20. 


1 12  THE  EXCHANGE  MECHANISM  OF  COMMERCE 

a  discount,  drafts  on  their  foreign  debtors.  Suppose,  for 
example,  that  exchange  in  New  York  on  London  were 
below  $484.65  =  £100.  Then  any  New  York  bank,  or 
other  person,  desiring  to  call  back  funds  held  in  London 
or  to  collect  a  debt  from  there,  would  prefer  to  pay  $2 
per  £100  for  importation,  and  have  $486.65  minus  $2,  or 
$484.65  for  each  £100,  than  to  get  less  than  that  amount 
by  selling  a  draft  at  a  very  low  rate  of  exchange.  This 
applies,  of  course,  only  when  the  circumstances  (or 
agreement)  are  such  that  the  creditor  is  obliged  to  bear 
the  risk  of  exchange  fluctuations.  Otherwise,  the  debtor 
would  be  expected  to  remit  draft  or  specie.  But  wher¬ 
ever  settlement  is  to  be  made  at,  in  this  regard,  the 
creditor’s  risk  (and  this  might  be  the  case,  for  example, 
where  a  creditor  bank  has  decided  to  withdraw  funds 
which  it  has  itself  put  on  deposit  abroad),  the  effect  of  a 
very  low  rate  of  exchange  on  any  point  would  be  to 
decrease  the  supply  of  drafts  on  that  point  and  substitute 
importation  of  specie.  With  exchange  so  low,  it  would 
pay  better  for  banks  to  withdraw  their  balances  from 
abroad  than  to  sell  drafts  upon  those  balances. 

A  low  rate  of  exchange,  below  $484.65  =  £100,  would 
also  tend  to  increase  the  demand  for  drafts.  For  such  a 
rate  of  exchange  would  make  it  worth  while  to  import 
gold  for  profit.  £100  of  full  weight  English  money  would 
be  worth,  in  this  country,  $486.65.  Subtracting  $2  as 
cost  of  transportation,  insurance,  etc.,  there  is  left 
$484.65.  If  the  gold  can  be  purchased  with  a  draft  on  an 
English  bank,  a  draft  which,  because  of  the  low  rate  of 
exchange,  costs  less  than  the  above  sum,  the  operation 
is  profitable.  (It  is  not  intended  to  assert  that  the  im¬ 
portation  of  so  small  a  sum  would  be  profitable.  Rather 
is  it  here  assumed  that  the  £100  is  only  a  part  of  a  much 


RATE  OF  EXCHANGE  AND  FLOW  OF  SPECIE  113 


larger  sum.)  The  low  price  of  drafts,  then,  stimulates 
the  demand  for  drafts  as  a  means  of  paying  for  English 
gold.  Thus,  on  the  supply  side  as  on  the  demand  side, 
there  is  a  limitation  on  the  extent  to  which  exchange  can 
fall.  The  lower  limit  of  exchange  fluctuations,  like  the 
upper  limit,  is  not,  however,  absolutely  and  permanently 
fixed,  since  the  cost  of  shipping  gold  may  vary,  —  for 
example,  by  higher  insurance  rates  in  war  time.  In 
practice,  the  ordinary  business  man  does  not  himself 
import  gold  but  takes  advantage  of  the  demand  for  his 
drafts  by  banks  which  use  the  drafts  to  pay  for  gold. 
With  importation  of  gold  from  England,  as  with  ex¬ 
portation  to  England,  allowance  must  be  made  for  the 
possible  slight  fluctuation  in  the  price  of  gold  in  terms 
of  pounds  sterling. 

§  4 

Circumstances  which  May  Cause  the  Rate  of  Exchange 
to  Fall  Below  what  is  Usually  its  Lower  Limit 

But  the  rate  of  exchange  may  sink  considerably  below 
what  is  ordinarily  the  gold  shipping  point  or  so-called 
specie  point,  in  times  of  panic  or  of  great  financial  disturb¬ 
ance  accompanied  by  a  relatively  large  supply  of  ex¬ 
change.1  The  principles  involved  are  the  same  at  such 
times  as  always,  and  the  factors  to  be  considered  are  the 
same,  but  one  of  these  factors,  loss  of  time  or  loss  of  in¬ 
terest,  comes  to  have  exceptional  importance.  If,  when 
panic  conditions  prevail,  sellers  of  goods  have  bills  on  for¬ 
eign  purchasers,  they  will  be  anxious  to  realize  on  these 
bills  at  once.  In  a  crisis,  both  cash  and  credit  are  rel¬ 
atively  hard  to  get.2  At  the  peak  of  the  crisis,  there  is  a 
so-called  stringency .  Interest  rates  are  high.  The  sellers  of 

1  See  Goschen,  The  Theory  of  the  Foreign  Exchanges,  London  (Effingham 
Wilson),  1896,  pp.  49-52  ;  also  Bastable,  The  Theory  of  International  Trade ,  Lon¬ 
don  (Macmillan),  1903,  pp.  85,  86.  3  See  Ch.  II  (of  Part  I),  §  7. 


1 14  THE  EXCHANGE  MECHANISM  OF  COMMERCE 

drafts  do  not  want  to  lose  interest  and  will,  therefore,  sell 
at  a  low  price  so  as  to  get  cash  immediately.  Especially 
if  their  creditors  are  pressing  them  hard  or  bank  loans  are 
difficult  to  get,  they  must  make  the  most  of  every  avail¬ 
able  resource,  at  once.  Rather  than  wait  for  importa¬ 
tion  of  gold,  they  would  sell  drafts  at  a  considerable 
reduction  below  the  usual  price.  It  is  the  same  when  the 
creditor  is  a  bank.  If,  at  such  a  time,  it  has  occasion 
to  draw  on  a  foreign  balance,  it  will  desire,  like  others,  to 
get  control  of  such  resources  at  once,  and  may  accept 
an  unusually  low  rate  of  exchange  rather  than  resort  to 
importation.  Neither  will  a  bank,  at  such  a  time,  be 
likely  to  import  gold  for  profit  unless  the  profit  is  excep¬ 
tionally  great.  To  buy  gold  abroad  is  to  subject  itself 
to  a  considerable  wait  pending  the  arrival  of  the  gold, 
during  which  time  part  of  its  funds  are  unavailable  for 
other  business.  But  during  a  crisis  a  bank  is  least  liable 
to  desire,  even  temporarily,  to  part  with  funds.  It  will 
be  induced  to  do  this  only  by  hope  of  an  exceptional 
profit,  only,  that  is,  if  the  price  of  the  exchange  which  it 
must  use  to  buy  foreign  gold  is  below  the  usual  gold 
importing  point.  Some  few  creditors  may  be  in  a  posi¬ 
tion  to  secure  immediate  payment  by  cable.  But 
those  whose  claims  are  based  on  the  export  of  goods 
cannot  expect  thus  to  be.  paid  in  advance  of  the  goods’ 
arrival.  Furthermore,  at  a  time  when  the  balance  of 
indebtedness  is  from  foreign  countries  to  us  (and  it  is 
such  a  time  that  we  are  considering),  a  part  of  that 
indebtedness  must  be  settled  by  shipments  of  gold  and  so 
necessarily  requires  an  interval  of  waiting  while  the  gold 
is  in  transit.  It  is  this  necessary  wait,  most  unwelcome 
at  a  time  of  stringency,  which  forces  the  rate  of  exchange 
below  the  usual  specie  point. 


RATE  OF  EXCHANGE  AND  FLOW  OF  SPECIE  115 

§5 

The  Cost  of  Money  Shipment  in  Domestic  Exchange 

It  should  be  noted  that  the  principles  of  domestic 
exchange  are  not  different  from  those  of  foreign  exchange. 
Money  has  to  be  shipped  from  one  part  of  the  United 
States  to  another,  as  it  has  to  be  shipped  between  coun¬ 
tries,  and  it  costs  something  to  ship  it.  But  in  domestic 
exchange  the  distances  average  less  and  the  expense  is 
smaller.  The  express  companies  will  carry  $1000  from 
New  York  to  Chicago  for  40  cents.1  To  carry  $486.65 
across  the  ocean,  pay  for  insurance,  weighing,  assay¬ 
ing,  etc.,  costs  about  $2  (in  large  quantities),  or  over 
$4  per  $1000,  making  an  expense  more  than  ten  times 
as  great. 

Of  course  even  the  trifling  charge  of  carrying  money 
about  our  own  country  might  well  affect  the  price  of  drafts 
to  that  extent,  and  in  fact  it  does  so  when  banks  buy  and 
sell  domestic  exchange  of  and  to  each  other.  But  in 
dealing  with  customers,  it  is  usual  for  the  banks  to  pay 
no  attention  to  this  expense.  On  the  contrary,  they  pay 
to  their  customers  when  buying  the  latters’  drafts,  and 
charge  them  when  selling  drafts  to  them,  a  more  nearly 
flat  rate,  which  includes  only  a  proper  fee  for  bank 
services,  reasonable  interest  for  time  elapsing  before 
maturity,  and  reasonable  insurance  for  the  possibility 
of  non-payment.  The  up  and  down  fluctuations  of  ex¬ 
change  between  the  shipping  limits  are  borne  by  the 
banks,  and,  since  they  gain  about  as  much  by  one  set  of 
fluctuations  as  they  lose  by  the  reverse  changes,  they  just 
about  make,  on  the  average,  a  fair  return  for  their  service 
to  the  community. 

1  See  Taussig,  Principles  of  Economics,  New  York  (Macmillan),  ign,  Vol.  I, 
p.  466. 


n6  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


As  a  matter  of  fact,  such  a  small  proportion  of  the 
total  business  done  requires  shipment  of  actual  money 
that  the  expense,  considering  the  low  cost  of  domestic 
shipments,  may  well  be  regarded  as  negligible.  To 
illustrate,  a  New  York  bank  might  have  sold  $1,000,000 
of  drafts  on  Chicago  and  bought  $998,000  of  drafts  on 
Chicago.  It  might  then  be  necessary  to  ship  $2000  to 
Chicago  at  a  cost  of  80  cents.  But  this  would  be  an 
expense  for  the  entire  business  transacted,  extremely 
small,  and  the  bank  might  well  ignore  it.  At  any  rate, 
such,  in  domestic  exchange  within  the  United  States,  is 
the  custom. 

§  6 

The  Long  Run  Effect  of  a  Balance  of  Payments  from  One 
Country  to  Another,  for  Commodities  or  Services 

So  far  we  have  discussed  chiefly  the  more  immediate 
effects,  upon  the  exchange  market,  of  given  conditions. 
Let  us  now  consider  some  of  the  long  run  or  ultimate 
effects.  •  These  depend  mainly  on  the  relative  prices 
or  levels  of  prices  of  goods  in  different  countries.  We 
have  seen  that  the  determination  of  the  level  of  prices  in 
any  country  is  expressed  in  the  equation 

MV  +  M'V'  =  pq  +  p'qf  4-  etc., 

where  M  is  money,  M '  is  bank  deposits,  V  and  V'  are 
velocities  of  circulation,  the  p’s  are  the  prices  respectively 
of  different  kinds  of  goods,  and  the  q’s  are  the  quanti¬ 
ties  of  these  goods.  We  have  seen,  also,  that  M'  tends 
to  increase  or  decrease  in  sympathy  with  M.  We  have, 
therefore,  drawn  the  conclusion  that  if,  in  any  country, 
M  increases  faster  than  the  q’s ,  prices  will  rise,  while 
if  M  decreases,  they  will  fall. 


RATE  OF  EXCHANGE  AND  FLOW  OF  SPECIE  117 


Bearing  in  mind  these  facts,  le*  us  now  consider  the 
long  run  influences  of  the  following  sources  of  exchange, 
on  the  rate  of  exchange  and  on  the  flow  of  money : 
a  —  Payments  for  commodities. 
a'  —  Payments  for  services,  e.g.  freight,  banking,  etc. 
b  —  Payments  of  funds  for  investments,  e.g.  interna¬ 
tional  lending  and  investing. 
c  —  Payments  of  interest,  dividends,  etc.  on  such  invest¬ 
ments. 

c'  —  Payments  from  home  funds  to  persons  of  one  sec¬ 
tion  or  country,  travelling  in  others. 
c" —  Payments  to  families  of  immigrants. 

Regarding  payments  for  commodities,  it  is  to  be  noted 
that  these  are  generally  purchased  where  they  can  be  got 
most  cheaply.  If  we  can  buy  most  commodities  more 
cheaply  in  England  than  here,  then  there  will  be  a  demand 
for  exchange  on  England  with  which  to  pay  for  them, 
and  exchange  on  England  will  rise.  If  such  a  condition 
(large  purchases  from  England)  lasts  for  any  great  while, 
the  rate  of  exchange  will  probably  go  high  enough  to 
encourage  the  exportation  of  gold.  As  a  consequence, 
since  in  each  country  there  is  a  relation  between  gold 
bullion  and  money,1  M ,  and  therefore  M '  also,  will 
increase  in  England  and  decrease  here.  Prices  will  rise 
there  by  comparison,  and  fall  here.  We  shall  cease  to 
buy  so  much  in  England,  and  England  will  buy  more  of 
us.  Great  purchases  by  us  of  foreigners  tend,  therefore, 
to  cause  great  purchases  by  foreigners  of  us.  Money 
flows  one  way  or  the  other  because  commodities  are  pur¬ 
chased,  all  things  considered,  where  they  are  cheapest. 
Briefly,  commodities  are  bought  where  prices  are  low; 
the  rate  of  exchange  elsewhere  on  these  low  price  places 

1  See  Ch.  I  (of  Part  I),  §  7. 


n8  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


is  therefore  high ;  gold  is  therefore  shipped  to  the  low 
price  places,  and,  since  it  is  in  large  part  coined,  because 
of  the  law  of  flow  between  bullion  and  coin,  prices  in 
those  places  tend  to  rise.  Though  equilibrium  is  ever 
being  departed  from,  it  is  ever  tending  to  be  restored. 

But  this  does  not  mean  that  if,  for  instance,  wheat  is 
cheaper  in  the  United  States  than  in  England,  and  Eng¬ 
land  buys  wheat  of  us,  we  then,  when  English  prices 
have  fallen  and  ours  have  risen,  begin  in  turn  to  buy 
wheat  of  England.  Wheat  never  becomes  cheaper  there 
than  here.  What  is  more  likely  to  happen  is  that,  when 
our  prices  rise  and  theirs  fall,  they  will  buy  less  of  our 
wheat  than  before,  and  either  raise  more  themselves, 
buy  more  elsewhere,  use  a  substitute,  or  simply  get  along 
with  less.  We,  on  the  contrary,  when  prices  have  fallen 
in  England  and  risen  here,  will  perhaps  buy  more  cotton 
cloth  in  England,  and  either  make  less  here,  buy  less  else¬ 
where  than  in  England,  substitute  it  for  another  kind 
of  cloth,  or  use  more  cloth. 

A  purely  superficial  consideration  might  lead  to  the 
conclusion  that  we  can  always  buy  goods  in  England  more 
cheaply  when  exchange  on  England  is  low.  A  lot  of 
English  goods  worth  £100  or,  in  our  money,  at  the  mint 
equivalent,  $486.65,  might  cost  $489  if  exchange  were 
high  and  only  $484  or  some  $5  less,  if  exchange  on  Eng¬ 
land  were  low.  But  the  conclusion  that  low  exchange  on 
England  means  an  opportunity  to  buy  goods  there  more 
cheaply  applies  with  certainty  only  on  the  supposition 
that  other  things  are  equal.  And  the  very  fact  that 
exchange  on  England  is  low  is  evidence  that  other  things 
are  not  equal.  Low  exchange  on  England  indicates,  as 
we  have  seen,  a  large  supply  of  drafts  on  England. 
Therefore  it  probably  indicates  that  we  have  been  selling 


RATE  OF  EXCHANGE  AND  FLOW  OF  SPECIE  119 


to  England  a  relatively  large  amount  and  buying  from 
England  a  relatively  small  amount  of  goods.  The  pre¬ 
sumable  cause  of  this  situation  is  relatively  high  prices 
there  and  relatively  low  prices  here,  as  compared  with 
other  times  or  seasons.  To  be  specific,  at  the  time  when 
low  exchange  would  enable  us  to  buy  in  England  £100 
worth  of  goods  for  $484,  it  is  probable  that  prices  in 
England  are  comparatively  high  and  that  £100  will  buy 
less  there  than  at  other  times,  compared  with  what  money 
will  buy  here.  Expressing  the  fact  in  general  terms,  we 
may  say  that,  when  money  has  flowed  from  here  to 
England  in  such  quantities  as  to  make  their  prices  higher 
and  ours  lower,  it  pays  to  sell  to  them  rather  than  to  buy 
from  them,  even  though,  at  such  a  time,  exchange  on 
England  is  below  par.  Low  exchange  on  foreign  coun¬ 
tries  does  tend  to  stimulate  importation,  and  high 
exchange  to  stimulate  exportation,  but  exchange  fluc¬ 
tuations  are  too  narrow  to  be  of  determining  influence. 
If,  for  example,  Americans  purchase  largely  in  England, 
the  necessity  of  remitting  will  make  exchange  on  Eng¬ 
land  high,  and  will  in  so  far  discourage  further  purchases 
from  England,  while  encouraging  sales  to  England  and 
encouraging  English  merchants  to  purchase  goods  here. 
But  exchange  cannot  rise  high  enough  to  influence,  very 
strongly,  the  importation  and  exportation  of  other  goods, 
because  so  slight  a  rise  causes  shipment  of  gold  (which, 
because  of  its  great  value  in  small  bulk,  is  inexpensive 
in  proportion  to  value,  to  ship).1  It  is  quite  likely,  then, 
that  excess  buying  of  Americans  from  abroad,  will  not 
be  checked  or  give  rise  to  corresponding  purchases  by 
foreigners  from  this  country,  until  a  flow  of  gold  has 
changed  relative  price  levels. 

1  Cf.  Ch.  VI  (of  Part  I),  §  9. 


i2o  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


Payments  for  freight,  banking,  and  other  services 
affect  exchange  in  the  same  way  as  do  payments  for 
commodities.  For  example,  payments  for  ship  trans¬ 
portation  services  are  supposedly  made  where  these 
services  can  be  secured  most  cheaply.  Thus,  a  maritime 
nation  like  Great  Britain  could  sell  to  us  the  services 
of  her  ships;  and  the  resulting  flow  of  money  towards 
Great  Britain  and  higher  prices  there  of  various  goods, 
would  give  rise  to  their  purchase  of  such  goods,  e.g. 
wheat,  from  us.  Great  Britain  might  be  said  to  export 
transportation,  banking,  and  other  services,  and  to 
import  food. 

Summarizing  the  conclusions  of  this  section  and  com¬ 
bining  them  with  previous  conclusions,  we  may  assert 

(1)  that  the  rate  of  exchange  in  one  country  on  another 
depends  upon  the  supply  of  and  the  demand  for  drafts ; 

(2)  that  the  supply  of  and  demand  for  drafts  depends  on 
the  direction  of  obligations  and  other  occasions  for  mak¬ 
ing  payments  between  the  countries ;  (3)  that  the  direc¬ 
tion  of  obligations,  etc.,  depends  largely  upon  the  surplus 
of  commodities  and  services  purchased  by  one  country 
of  another ;  and  (4)  that  the  surplus  of  commodities  and 
services  purchased  by  one  country  of  another  depends 
upon  the  relative  prices  of  those  commodities  and  ser¬ 
vices  in  (or  as  sold  by)  the  countries  concerned. 

§  7 

The  Long  Run  Effect  of  International  Investments  upon 
the  Rate  of  Exchange  and  the  Flow  of  Money 

We  have  next  to  examine  the  long  run  effect  of  inter¬ 
national  (or  interterritorial)  investments  upon  the  rate 
of  exchange  and  upon  the  flow  of  money.  If,  for  example, 


RATE  OF  EXCHANGE  AND  FLOW  OF  SPECIE  121 


Englishmen  invest  in  the  United  States,  if  we  borrow  of 
them  or  sell  securities  and  other  property  to  them,  what 
is  the  immediate  effect?  It  is  to  increase  the  supply, 
here,  of  drafts  on  England,  or  decrease  the  demand  for 
such  drafts,1  and  so  to  lower  the  rate  of  exchange  on 
England;  and  to  increase  the  demand  in  England  for 
drafts  on  the  United  States,  raising  there  the  rate  of 
exchange  on  us  (though  this  fact  is  obscured  by  the  cus¬ 
tom  of  quoting  the  rate  in  England,  as  here,  in  American 
money).  Then  it  becomes  worth  while  for  American 
banks  to  import  and  for  English  banks  to  export,  gold. 
As  a  second  consequence,  therefore,  gold  flows  from 
England  to  the  United  States.  Since  much  of  this  gold, 
because  of  the  laws  of  interflow  between  gold  bullion  and 
gold  coin2  is  a  subtraction  from  English  money  and  an 
addition  to  American  money,  prices  will  tend  to  fall  in 
England  and  will  tend  to  rise  in  the  United  States. 
Then  it  will  become  profitable  for  us  to  buy  more  goods 
in  England,  while  England  will  buy  less  goods  of  us.  As  a 
next  consequence,  the  obligations  from  us  to  them  will 
be  in  excess,  and  the  rate  of  exchange  on  London  will 
rise.  Therefore,  gold  will  be  shipped  back  again  in 
return  for  other  goods.3  This  return  flow  must  continue 
until  English  and  American  prices  (supposing  no  new 
influences  to  intervene)  are  in  about  the  same  relation  as 
before  the  lending  or  investing  began.  That  means  that 
in  each  country  the  quantity  of  money  must  be  in  about 
the  same  relation  as  before  to  the  quantity  of  goods. 
Speaking  roughly,  we  may  say  that  the  invested  money 
flows  back  for  goods,  or  that  what  is  really  invested  is 


1 

\ 


_ 


1  See  Ch.  IV  (of  Part  I),  §  2. 

2  See  Ch.  I  (of  Part  I),  §  7. 

*  See  Taussig,  Principles  of  Economics ,  pp.  468-471. 


122  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


usable  capital.  If  Englishmen  invest  in  the  securities 
of  a  new  American  railroad,  what  we  really  get  from 
England  may  be  steel  rails,  engines,  etc.,  or  cloth,  coal, 
and  other  goods  to  be  consumed  by  us  while  we  are  mak¬ 
ing  the  rails  and  engines.  International  lending  and 
investing  is  most  decidedly  a  lending  and  investing  of 
capital  wealth  in  such  forms  as  are  here  suggested,  and 
not  merely  a  flow  of  money. 

Foreign  investments  here  may,  in  fact,  take  largely 
the  form  of  usable  capital,  without  the  intermediation  of 
these  stages  of  inflow  and  outflow  of  money.  The  fall 
in  the  rate  of  exchange  on  foreign  countries,  consequent 
on  such  investments,  itself  tends  to  make  foreign  goods 
slightly  cheaper  in  terms  of  American  money  and  so  to 
encourage,  somewhat,  importation  of  usable  capital, 
even  before  the  tendency  to  importation  is  accentuated 
by  the  change  in  relative  price  levels.1  And  if  gold  does 
flow  in  to  some  extent,  the  tendency  for  it  to  flow  out 
for  other  goods  may  show  itself  so  quickly  that,  aside 
from  the  first  slight  inflow,  the  purchase  of  capital  goods 
abroad  keeps  pace  with  the  investments  made  by 
foreigners  here.  In  effect,  the  foreign  investors  send 
us,  perhaps  almost  at  once,  capital  other  than  money. 

§8 

The  Long  Run  Effect  of  Various  Other  Payments  from 

One  Country  to  Another 

The  third  group  of  purposes  for  which  bills  of  exchange 
and  money  are  sent  from  country  to  country,  is  to  pay 
interest,  dividends,  and  profits  on  investments,  to  send 
remittances  to  persons  travelling  abroad,  and  to  send 

1  Cf.  §  6  of  this  chapter  (V  of  Part  I). 


RATE  OF  EXCHANGE  AND  FLOW  OF  SPECIE  123 


remittances  to  the  families  of  immigrants.  We  have 
just  seen  that,  when  foreigners  invest  here,  such  invest¬ 
ment,  in  the  long  run,  is  an  investment  of  consumable 
goods,  or  of  the  machinery  of  production,  or  both. 
In  the  long  run,  what  flows  here  is  goods  rather  than 
money.  After  a  time,  interest  is  earned  on  the  bonds 
foreign  investors  have  purchased,  dividends  are  declared 
on  the  stock,  etc.  Having  secured  the  use  of  foreign 
capital,  we  must  pay  interest  on  it.  There  arises  then 
a  demand  for  exchange  on  foreign  countries  in  order  to 
pay  these  investors  their  profits.  This  demand  makes 
exchange  on  foreign  countries  high  (while  on  us  it  is 
low),  and  it  becomes  worth  while  for  gold  to  be  shipped 
from  us  to  them.  The  same  kind  of  result  occurs  if 
and  when  the  invested  capital  is  itself  repaid  ( i.e .  if 
American  investors  buy  back  from  foreigners  American 
land,  securities,  etc.).  Consequently  foreign  prices 
tend  to  rise  and  ours  to  fall.  Therefore,  foreigners  buy 
more  goods  of  us  than  previously,  and  the  money  flows, 
chiefly,1  back  here.  In  the  last  analysis  the  interest 
and  dividends  received  are  practically  all  in  the  form  of 
food,  raw  material,  manufactured  goods,  etc.,  and  are 
not  merely  money. 

So,  in  the  last  analysis,  remittances  to  Americans 
travelling  abroad  and  to  the  families  of  immigrants, 
have  the  same  result.  Our  countrymen  travelling  abroad 
receive  from  home,  in  the  long  run,  not  money,  but 
goods.  Of  course  they  may  purchase  chiefly  European 

1  Not,  perhaps,  entirely,  because  the  somewhat  larger  amount  of  goods  in 
foreign  countries,  consequent  on  the  flow  back  to  us,  for  goods,  of  the  interest 
and  dividends  money,  may  require  a  little  more  money  to  be  circulated.  But 
the  rapidity  of  circulation  of  money  and  the  fact  that  it  is  the  basis  for  bank 
credit  circulating  even  more  rapidly,  would  seem  to  signify  that  a  very  large 
increase  in  the  quantity  of  goods  abroad  would  call  for  but  a  slight  increase  in 
money. 


124  THE  exchange  mechanism  of  commerce 

goods,  but,  if  so,  they  thereby  put  some  Europeans  in  a 
position  to  get  American  goods.  In  the  long  run,  it  is 
chiefly  goods  other  than  money  which  flow  in  trade. 

§  9 

Summary 

Though  the  use  of  bills  of  exchange  obviates,  to  a  large 
degree,  the  necessity  of  shipping  money  or  gold,  never¬ 
theless,  as  we  have  seen,  balances  must  be  thus  settled. 
A  continuous  balance  of  obligations  in  one  direction  will 
cause  gold  to  be  shipped,  by  affecting  the  rate  of  exchange. 
It  will  become  cheaper  to  settle  indebtedness  by  shipping 
gold,  and  the  exportation  or  importation  of  gold  may  be 
undertaken  for  profit.  A  high  rate  of  exchange,  here,  on 
any  country,  will  cause  shipments  of  gold  to  that  country ; 
a  low  rate  will  cause  importations  of  gold  from  that 
country.  Exportation  of  gold  to  any  country  will  tend 
to  keep  down  the  price  of  drafts  on  that  country  by 
decreasing  the  demand  for  them  (debts  being  settled  by 
gold)  and  by  increasing  the  supply  of  them  (drafts  being 
drawn  on  consignees  when  gold  is  shipped  for  profit). 
Importation  of  gold  from  any  country  will,  analogously, 
tend  to  keep  up  the  price  of  drafts  on  that  country  by 
decreasing  the  supply  of  drafts  (gold  being  imported 
instead  of  drafts  being  drawn),  and  by  increasing  the 
demand  for  them  (to  purchase  foreign  gold  imported  for 
profit).  The  rate  of  exchange  can,  therefore,  go  above 
or  below  par  by  only  about  the  cost  (with  perhaps  a 
reasonable  profit)  of  shipping  specie.  But  at  a  time  of 
stringency,  when  most  business  men  in  a  country  desire 
to  secure  funds  as  quickly  as  possible,  the  rate  may  go 
somewhat  lower  than  what  would  usually  be  the  gold 
importing  point. 


RATE  OF  EXCHANGE  AND  FLOW  OF  SPECIE  125 


In  the  long  run,  specie  tends  to  flow  to  those  places 
where  other  desired  goods  are  cheapest  (and  specie, 
therefore,  of  most  value  or  purchasing  power  in  com¬ 
parison  with  those  goods),  and  from  places  where  goods 
other  than  money  are  high.  So  lending  and  investing 
between  countries  is  really,  in  the  main,  a  lending  and 
investing  of  capital  goods  rather  than  money ;  for  the 
flow  of  money  changes  the  relative  levels  of  prices  of  the 
countries  concerned,  and  brings  about  a  reverse  flow. 
The  same  principle  applies  to  the  payments  of  interest 
and  dividends,  remittances  to  persons  abroad,  etc.  The 
use  of  bills  of  exchange  and  money  complicates  these 
business  relations  of  countries  and  territories ;  but  it 
does  not  change  the  essential  fact  that  trading,  lending, 
investing,  and  profiting  involve,  in  the  last  analysis, 
capital  and  consumable  goods  rather  than  money. 
Money  (as  well  as  bills  of  exchange,  etc.)  is  a  part  of  our 
machinery  of  production,  but  only  a  part,  and  it  is  as  a 
part  of  this  machinery  that  it  is  of  use  in  international 
and  interterritorial  business  relations. 


CHAPTER  VI 


Further  Considerations  Regarding  the  Rate  of 

Exchange 

§  i 

The  Price  of  Long  Drafts  Determined  in  Part  by  the  Rate 

of  Interest  or  Discount 

The  price,  here,  of  bills  of  exchange  on  any  given 
country,  at  a  given  time,  may  be  regarded  as  being  made 
up  chiefly  of  two  factors.  These  are,  the  rate  of  interest 
or  discount,  and  the  pure  rate  of  exchange.  The  pure 
rate  of  exchange  is  the  rate  on  demand  or  sight  drafts. 
As  to  these  there  is  no  element  of  time  except,  of  course, 
the  time  required  for  the  carriage  of  the  drafts  from  the 
one  country  to  the  other.  Ignoring  the  slight  interest 
thus  involved,  some  of  the  yearly  rate,  we  may  say 
that  the  rate  of  exchange  on  sight  drafts  is  pure  exchange. 
It  is  the  rate  of  exchange  on  sight  drafts,  which  we  have 
in  mind  when  we  say  that  exchange  can  ordinarily  fluc¬ 
tuate  only  between  the  specie  points  or  shipping  limits. 

But  with  other  drafts,  the  rate  of  interest  or  discount 
is  an  important  fact  to  consider.  Many  of  these  drafts 
are  drawn  to  run  for  periods  of  60,  90,  and  even  120 
days  after  sight.  Since  payment  on  such  a  draft  can¬ 
not  be  required  before  maturity,  the  investing  pur¬ 
chaser  of  the  draft  is  in  the  position  of  a  lender  or  in¬ 
vestor  until  then,  unless,  of  course,  he  sells  to  another. 
As  a  lender  or  investor,  he  will  wish  to  get  interest  on  his 
investment,  and  since  the  amount  he  is  to  receive  at 

126 


FURTHER  CONSIDERATIONS  ON  EXCHANGE  127 


maturity  is  definitely  fixed,  he  can  secure  interest  only 
by  paying  somewhat  less  than  this  amount  when  he  buys 
the  draft.  In  short,  the  investing  purchaser  must  dis¬ 
count  the  draft  for  the  time  it  has  to  run,  and  the  amount 
of  this  discount  will  depend  upon  the  rate  of  discount  or 
the  rate  of  interest.  Since  the  investing  purchaser  is 
sure  to  discount  the  draft,  the  exchange  bank  which  buys 
it  in  the  first  instance,  intending  to  have  it  sold  in  the 
exchange  market,  must  also  discount  it.  Thus,  even 
if  exchange  here,  on  England,  were  above  par,  say 
$488.65  =  £100,  a  draft  for  £100  having  some  time  to 
run  might,  because  of  the  element  of  time,  be  selling 
for  $482. 

It  may  be  noted  in  passing  that  an  importer  can,  in 
effect,  secure  a  cash  discount  on  his  purchases  by  remit¬ 
ting  a  60-day  or  90-day  draft.  Suppose  he  has  pur¬ 
chased  £100  worth  of  goods  in  London,  payment  to  be 
made  in  90  days.  If  it  is  agreed  that  he  shall  remit,  he 
can,  just  before  maturity  of  the  debt,  buy  a  draft  and 
send  it.  But  he  can  also,  if  he  prefers,  buy  immediately 
•  a  draft  payable  in  90  days.  If  he  does  this,  he  will  get 
the  draft  at  a  discount.  His  goods  will  cost  him  less 
because  he  is  prepared  to  pay  at  once.  As  a  matter  of 
fact,  banks  frequently  sell  such  time  drafts  to  importers. 

§  2 

How  Long  Drafts  on  Foreign  Countries  are  Held  as  Invest¬ 
ments  by  American  Banks 

The  fact  that  many  drafts  run  for  periods  of  several 
months  and,  being  purchased  at  a  discount,  yield  interest 
to  the  holders  of  them,  makes  these  drafts  desirable  as 
short  term  investments.  Sometimes  the  bank  which 


1 


128  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


originally  purchases  long  drafts,  in  the  “drawing” 
country,  prefers  to  realize  this  interest,  rather  than  to 
have  such  drafts  sold  at  once  in  the  discount  market  of 
the  “accepting”  country.  Let  us  suppose  that  for  a 
time  the  discount  rate  on  safe  drafts,  in  the  German 
market,  is  7  per  cent,  while  conditions  of  business  in  the 
United  States  are  such  that  American  banks  cannot 
earn  more  than  about  5  per  cent  on  their  capital  used 
at  home.  Under  these  conditions,  an  American  bank 
purchasing  drafts  on  Germany,  having  some  time  to  run, 
would  probably  not  send  them  to  Germany  for  imme¬ 
diate  discount  at  the  comparatively  high  rates  there 
prevailing ;  but  would  be  more  apt  to  hold  them  in  its 
own  vaults,  or  have  them  held  for  its  account  by  its 
German  correspondent,  until  maturity  or  near  maturity, 
in  order  to  realize  a  larger  sum. 

Before  describing  the  method  of  procedure  commonly 
followed  when  drafts  on  foreign  countries  are  held  in  its 
own  vaults  for  investment  by  an  American  bank,  it  is 
essential  to  note  that  bills  of  exchange  or  drafts  used  in 
international  trade,  are  generally  made  out  in  duplicate, 
the  different  copies  being  known  as  firsts  and  seconds. 
This  has  long  been  the  custom  in  such  trade,  as  a  safe¬ 
guard  against  possible  loss  or  miscarriage  of  one  of  the 
drafts.  Whichever  draft  first  reaches  its  destination  is 
presented  for  acceptance,  and  when  it  is  paid  the  debt 
is  cancelled.  Extra  copies  of  bills  of  lading  and  other 
documents  may  also  be  made. 

Consider  now  the  procedure  which  may  be  followed  by 
the  investing  American  bank  in  holding  the  drafts  on 
Germany.1  On  the  day  of  purchase  by  an  American 

1  Described  in  Margrafrf,  International  Exchange,  Chicago  (Fergus  Printing 
Co.),  1903,  p.  61. 


FURTHER  CONSIDERATIONS  ON  EXCHANGE  129 


bank  of  drafts  on  German  banks  or  merchants,  the 
‘‘firsts ”  of  these  drafts  or  bills  of  exchange  are  not 
indorsed  by  the  American  bank  to  the  order  of  its 
German  correspondent,  as  would  be  done  if  the  drafts 
were  to  be  sent  over  for  immediate  discount  and  credit 
or  for  holding  abroad  subject  to  cable  order.  On  the 
contrary,  there  are  written  on  the  faces  of  these  firsts 
the  words  “for  acceptance  only.”  Then  the  German 
correspondent  bank  to  which  the  drafts  are  forwarded, 
is  requested  to  have  them  “accepted,”  and  to  hold  them 
subject  to  the  call  of  the  seconds  properly  indorsed  by 
the  American  bank.  Any  duplicate  documents,  such  as 
duplicate  bills  of  lading,  attached  to  the  seconds,  are 
detached  and  sent  to  the  German  correspondent  bank, 
which  is  instructed  to  turn  these  documents  over  to 
the  drawees  provided  the  latter  accept  the  drafts.  The 
seconds,  clean  of  all  other  papers,  are  kept  by  the  invest¬ 
ing  American  bank.  On  the  face  of  each  of  these  seconds 

is  written:  “Accepted  firsts  held  by - ,”  giving  the 

name  of  the  bank  to  which  the  firsts  were  sent.  The 
American  bank  gets  as  profit  the  difference  between  the 
discounted  value  paid  for  the  drafts  and  the  amount 
realizable  from  them  at  maturity,  minus  the  corre¬ 
spondent’s  commission. 

When  the  date  of  maturity  approaches,  the  American 
bank  will  indorse  the  seconds,  presumably  to  the  above 
described  correspondent  bank,  and  forward  them  to  it  for 
credit.  As  a  matter  of  fact,  the  American  bank  need  not, 
if  it  prefers  otherwise,  send  the  indorsed  seconds  to  the 
foreign  bank  which  holds  the  firsts.  The  seconds  can, 
if  occasion  requires,  be  indorsed  to  any  bank,  for  the 
firsts  are  held  subject  to  the  call  of  the  indorsed  seconds, 
and  must  be  handed  over  (or  credited,  as  the  case  may  be) 


130  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


on  presentation  of  these  indorsed  seconds.1  The  two 
together  constitute  a  completed  bill. 

The  drafts  may  be  so  indorsed  and  forwarded  to  the 
correspondent  bank  for  discount  and  credit  at  any  time 
when  rates  of  discount  make  it  seem  profitable  to  send 
them.2  They  are  not  necessarily  held  until  maturity. 
But,  in  any  case,  the  amount  realized  (minus  commis¬ 
sion)  is  placed  to  the  American  bank’s  credit,  and  it  can 
then  sell  drafts  on  this  credit.  Of  course,  the  investing 
bank  takes  some  risk  of  fluctuations  in  the  rate  of  ex¬ 
change.  If  the  rate  falls,  the  bank  will  get  somewhat 
less  when  it  sells  its  drafts  on  this  credit.  If,  on  the 
other  hand,  the  rate  of  exchange  on  Germany  was  low 
when  the  American  bank  bought  the  drafts  for  invest¬ 
ment,  so  that  they  could  be  purchased  more  cheaply, 
and  is  high  when  the  bank  is  ready  to  sell  its  own  drafts 
on  the  credit  secured  (at  maturity  or  before),  then  the 
bank  will  realize  an  additional  profit. 

But  the  American  bank,  even  if  desiring  to  avail  itself 
of  higher  interest  rates  existing  temporarily  in  Germany, 
will  often  prefer  to  indorse  the  drafts  it  has  purchased 
to  its  German  correspondent,  and  have  them  held  by  the 
latter,  after  acceptance,  subject  to  instructions  by  cable. 
An  advantage  of  this  method  lies  in  the  possibility  of 
immediate  sale  at  any  time  before  maturity  if  low  dis¬ 
count  rates  make  it  desirable  to  have  the  drafts  sold.  If 
to  have  them  sold  does  not  appear  to  be  profitable,  they 
can  be  retained  till  maturity  for  account  of  the  remitting 
bank. 

1  Margraff,  International  Exchange,  p.  65.  1  Ibid.,  p.  63. 


FURTHER  CONSIDERATIONS  ON  EXCHANGE  13 1 

§3 

Influence  on  the  Price  of  Long  Drafts ,  of  Interest  Rate 
in  Drawing  Country  and  of  Interest  Rate  in  Country 
Drawn  Upon 

We  have  seen  that  the  prices  of  bills  of  exchange,  other 
than  sight  bills,  depend  upon  the  rate  of  interest.  We 
have  also  seen  that  bills  of  exchange  involve  two  trading 
countries ;  and  in  the  previous  section  attention  has  been 
called  to  the  fact  that  the  rate  of  interest  in  one  such 
country  may  be  different  from  the  rate  of  interest  in  the 
other.  Which  of  the  two  rates  of  interest  or  discount 
will,  in  such  a  case,  determine  the  price  of  a  bill  of 
exchange  drawn  in  one  country  on  the  other  ? 1 

In  the  first  place,  let  us  suppose  interest  to  be  com¬ 
paratively  high  in  the  country  where  the  bill  in  question  is 
drawn,  say  the  United  States,  and  comparatively  low  in 
the  country  on  which  it  is  drawn,  say  England.  On 
this  assumption,  the  amount  of  the  discount,  and, 
therefore,  the  price  of  the  draft,  will  depend  on  the  rate 
of  interest  or  discount  in  the  country  on  which  the 
draft  is  drawn,  viz.,  England.  For  if  the  rate  of  discount 
in  England  is  very  low,  then  the  draft  will  sell,  in  England, 
for  a  high  price,  that  is,  for  a  price  comparatively  near 
the  maturity  value.  And  since  it  will  thus  sell  in  the 
English  discount  market  for  a  high  price,  therefore  the 
American  bank  which  first  allows  cash  for  it  to  a  mer¬ 
cantile  or  other  establishment,  can  afford  to  pay  a  high 
price  for  the  draft.  The  American  bank  which  buys  the 
draft  does  not  need  to  wait  until  maturity  to  realize  on  it, 
but  can  have  it  discounted  immediately  on  its  arrival 

1  The  reasoning  here  followed  is  that  of  Goschen,  The  Theory  of  the  Foreign 
Exchanges ,  third  edition,  London  (Effingham  Wilson),  1896,  p.  137. 


13  2  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


at  London.  The  American  bank  does  not  need  to  lose, 
for  a  long  period,  the  use  of  its  capital.  As  a  conse¬ 
quence,  competition  among  American  banks  will  force 
up  the  price  of  such  drafts  to  somewhere  near  what  they 
will  bring  in  the  English  discount  market.  Our  conclu¬ 
sion  must  be  that  if  the  interest  rate  in  the  country 
drawn  upon  is  the  lower,  this  interest  rate  determines  the 
price  of  long  drafts  in  the  drawing  country  also. 

But  suppose,  on  the  other  hand,  that  the  rate  of  inter¬ 
est  is  higher  in  the  country  drawn  upon,  say  England, 
than  in  the  drawing  country,  the  United  States.  On  this 
hypothesis,  a  draft  on  England  would  be  discounted  in 
England  at  a  comparatively  high  rate,  that  is,  would 
bring  a  relatively  low  price.  Would  its  price  be  equally 
low  in  the  drawing  country?  Certainly  if  the  pur¬ 
chasing  bank  in  the  United  States  intended  to  send  the 
draft  at  once  abroad  for  discount,  such  a  bank  could  not 
afford  to  pay  more.  To  do  so  would  mean  a  definite 
loss.  But,  on  our  present  hypothesis,  a  draft  purchased 
at  the  low  price  based  on  the  discount  rate  in  England, 
will  yield  a  greater  return  on  the  investment  than  the 
prevailing  rate  of  interest  in  the  United  States,  the  draw¬ 
ing  country.  Competition  among  banks  in  the  drawing 
country,  desiring  to  invest  in  such  bills  of  exchange,  may, 
therefore,  raise  the  price  of  the  draft  slightly  above  its 
value  in  the  country  drawn  upon ;  for  even  then  it  will 
bring  a  larger  return  by  way  of  interest  than  is  being 
realized  generally  in  the  drawing  country.  The  seller 
of  the  draft  may  hope  to  get  for  it  a  little  more  than  the 
price  it  would  bring  in  England,  while  the  purchasing 
bank  realizes  more  than  the  rate  of  interest  in  the  United 
States,  enough  more  to  induce  this  bank  to  buy  and  hold 
the  draft  as  an  investment,  or  have  it  held  for  its  account 


FURTHER  CONSIDERATIONS  ON  EXCHANGE  133 


abroad.  When,  therefore,  the  rate  of  interest  is  lower 
in  the  drawing  country,  the  price  of  the  draft  will  be 
determined,  at  least  in  small  part,  by  that  rate  of  interest. 
It  should  be  added  that  if  conditions  change  during  the 
life  of  a  draft,  so  that  interest  is  lower  in  England,  such 
a  draft  held  here  as  an  investment  is  likely  to  be  sent 
there  for  immediate  discount  at  the  high  price  realizable. 

As  a  matter  of  fact,  the  discount  rate  in  London,  as 
also  in  other  great  European  centres,  is  almost  always 
lower  than  in  New  York.  The  usual  rule,  therefore,  is 
for  American  banks  to  have  their  drafts  on  England 
discounted  there  at  once.  Their  capital  can  be  more 
profitably  invested  at  home  than  in  holding  long  drafts 
on  English  debtors.  On  the  other  hand,  English  banks 
do  not  have  long  drafts  which  they  buy  on  Americans, 
discounted  in  the  United  States.  The  absence,  here,  of 
a  rediscount  market,  makes  it  practically  impossible  for 
them  to  do  this,  though  the  usually  higher  rates  of  dis¬ 
count  prevailing  in  the  United  States  might,  in  any  case, 
disincline  them  to  have  such  drafts  sold  on  this  side. 
There  are,  in  practice,  very  few  long  bills  drawn  upon 
the  United  States,  and  such  long  bills  as  are  drawn  upon 
this  country  are  usually  held  till  maturity,  for  account 
of  the  foreign  remitting  banks,  by  their  American 
correspondents.1 

§4 

How  and  Why  the  Bank  Discount  Rate  A fleets  the  Price  0] 
Demand  Drafts  and  the  Flow  of  Specie 

Changes  in  the  relative  rates  of  interest  in  different 
countries  affect,  temporarily,  rates  of  exchange  and  the 
flow  of  specie;  though  such  changes  in  relative  rates 


1  See  Ch.  Ill  (of  Part  I),  §  8. 


134  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


of  interest  do  not  permanently  affect  the  international 
distribution  of  specie,  independently  of  comparative  price 
levels.  For  example,  much  is  said  of  the  influence  on 
the  rate  of  exchange  and  on  the  flow  of  gold,  of  the  Bank 
of  England  discount  rate.  If  the  Bank  of  England, 
because  of  too  rapidly  expanding  loans  or  because  of 
depletion  of  reserves,  raises  its  rate  of  discount,  being 
followed  in  this  move  by  the  other  English  banks,  its 
doing  so  has  a  tendency  to  lower  the  rate  of  exchange 
in  England  on  the  United  States  and  other  countries, 
and  to  raise  the  rate  in  the  United  States  and  elsewhere 
on  England.  It  has  this  effect  because  the  increased 
interest  in  England  tempts  to  investment  there  rather 
than  in  the  United  States.  English  banks  are  more 
likely  to  invest  current  funds  at  home,  and  may  even  draw 
on  debtor  banks  in  the  United  States  and  other  countries. 
American  and  other  banks  may  be  tempted  to  make 
short  term  loans  in  England  or  to  hold  or  have  held  until 
maturity,  long  bills  which  they  would  otherwise  have 
immediately  discounted.  This  holding  of  drafts  until 
maturity  will  compel  them  to  buy  more  drafts  on  Eng¬ 
land  than  otherwise  would  be  necessary,  in  order  to 
maintain  their  usual  balances.  The  general  result  of  a 
high  discount  rate  in  England  is,  therefore,  a  high  rate 
of  exchange  on  and  a  flow  of  gold  to  England.1  Similarly, 
a  sharp  rise  in  the  discount  rate  in  New  York  would  tend 
to  produce  elsewhere  a  high  rate  of  exchange  on  New 
York,  and  would  tend  to  cause  a  flow  of  gold  to  New 
York. 

But  we  have  seen  that  the  flow  of  gold  from  country  to 
country  is  determined  by  comparative  prices  of  goods. 
If,  because  of  a  high  discount  rate  in  England,  gold  flows 

^Goschen,  The  Theory  oj  the  Foreign  Exchanges,  third  edition,  pp.  1 29-140. 


FURTHER  CONSIDERATIONS  ON  EXCHANGE  135 


to  England  in  large  quantities,  so  that  prices  rise  there 
and  fall  here ;  then  England  becomes  a  good  place  to 
sell  to,  and  the  United  States  (and  other  countries)  by 
comparison  a  good  place  to  buy  from.  The  gold  will 
therefore  flow  back  for  goods  until  prices  are,  relatively, 
what  they  were  before.  Americans,  or  American  banks, 
who  have  invested  in  England  because  of  the  high  rates 
of  interest  there,  will  have  invested,  in  fact,  not  money 
but  other  capital. 

But  at  this  point  a  qualification  must  be  made,  based 
on  the  fact  that  the  bank  rate  of  discount  influences,  in¬ 
directly,  the  prices  of  goods.  The  bank  discount  rate  in¬ 
fluences  prices  by  affecting  credit.  It  was  pointed  out,  in 
Chapter  II  (of  Part  I)  ,x  that  the  general  level  of  prices  in 
a  modern  industrial  and  commercial  community  or  coun¬ 
try  is  determined  not  alone  by  the  quantity  of  money  and 
its  velocity  of  circulation  and  by  the  volume  of  trade,  but 
also  by  the  amount  and  velocity  of  bank  credit.  The 
relationship  set  forth  was  expressed  in  the  equation, 

MV  +  M'V'  —  pq  +  p'q'  +  etc. 

Ordinarily,  it  was  shown,  M'  maintains  a  fairly  constant 
rather  than  a  violently  fluctuating  ratio  to  M.  The 
total  amount  of  this  M '  or  bank  credit  in  a  community 
will  depend  partly  on  the  business  needs  and  customs 
of  that  community,  but  partly,  also,  on  the  quantity  of 
such  credit  which  the  banks  can  safely  keep  in  circula¬ 
tion  with  a  given  support  of  cash  reserves.  If  lack  of 
confidence  depletes  these  reserves,  or  if  banks  have 
expanded  their  credit  too  far  for  their  reserves  safely  to 
support,  contraction  of  this  credit  is  necessary.  The 
banks  discourage  borrowing,  and  so  decrease  the  amount 


136  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


of  circulating  bank  credit  by  charging  higher  interest 
to  borrowers,  i.e.  by  raising  their  rates  of  discount. 

Suppose,  then,  that  because  of  a  condition  of  business 
distrust  and  comparatively  small  reserves,  the  Bank  of 
England  and  other  English  banks  raise  their  rates  of 
discount.  As  a  consequence,  there  is  a  fall  in  the  rate 
of  exchange  on  New  York,  and,  in  New  York,  a  rise 
in  the  rate  on  London.  There  follows  a  flow  of  gold  to 
London  and  the  bank  reserves  there  are  replenished. 
But  this  gold  does  not,  at  least  for  the  time  being,  raise 
English  prices  and  result  in  a  corresponding  flow  of  gold 
back  to  the  United  States  (and  other  countries) ;  for 
the  increase  of  the  bank  charges  on  loans  discourages 
borrowing  from  banks,  and  so  tends  to  decrease  M' . 
In  the  equation,  MV  +  M'V'  =  pq  -f  p'q'  +  etc.,  for 
England,  the  p’s  may  not  be  at  all  increased  or  may  even 
be  decreased.1  Only  when  bank  credit,  in  England,  is 
again  allowed  to  expand,  will  the  full  effect  of  the  inflow 
of  gold  be  felt  in  higher  prices.  So  long  as  high  discount 
rates  keep  the  total  of  circulating  bank  credit  in  England 
less  than  before  in  relation  to  money,  the  inflow  of  gold 
does  not  so  much  raise  prices  as  substitute  itself  for  bank 
credit.  Hence,  gold  will  not  flow  out  again,  for  goods.2 

1  Cf.  Goschen,  The  Theory  of  the  Foreign  Exchanges,  p.  129,  where  this  idea, 
though  not  developed,  seems  to  be  implied. 

*  Just  before  the  outbreak  of  the  European  war  now  (August,  1914)  in 
progress,  the  efforts  of  European  investors  to  dispose  of  securities  for  gold  and 
the  closing  of  the  principal  bourses  of  the  world,  caused  a  flood  of  sales  on  the 
New  York  stock  exchange,  large  purchases  of  these  securities  by  Americans,  and 
an  unusually  strong  tendency  for  gold  to  flow  abroad.  In  view  of  the  sudden¬ 
ness  and  violence  of  the  movement,  it  was  perhaps  not  unwise  that  the  New 
York  stock  exchange  should  be  temporarily  closed  (see  New  York  World, 
August  1,  1914)  and  that  the  sale  of  securities  here  by  foreigners  should  thus 
be  made  difficult.  It  is  true  that  the  flow  of  gold  abroad  (and  we  are  not  here 
concerned  with  any  other  reason  for  the  closing  of  the  exchange)  is  not  ordinarily 
a  proper  cause  for  alarm,  can  be  checked  by  a  rise  in  bank  discount  rates  if  such 
a  check  is  necessary,  and  will  in  any  case,  if  long  continued,  give  rise  to  a  re- 


FURTHER  CONSIDERATIONS  ON  EXCHANGE  137 

§5 

Effect  of  a  Panic  in  One  Country  on  Conditions  in  Other 

Countries 

Since  prices  and  interest  rates  in  different  countries 
are  related,  a  panic  in  one  country  cannot  usually  be 
altogether  without  effect  on  other  countries  having  close 
commercial  relations  with  it,1  though  these  other  coun¬ 
tries  may  not  be  affected  acutely.  When,  for  any  reason, 
in  a  country  of  large  commercial  importance,  business 
confidence  gives  place  to  acute  distrust,  and  the  banks, 
with  reserves  depleted  or  fearing  that  the  reserves  will  be 
depleted,  raise  their  discount  rates,  their  action  will 
affect  discount  rates  in  commercially  related  countries. 
The  strain  on  the  bank  reserves  of  the  first  country,  and 
the  rise  of  the  discount  or  interest  rate,  tends  to  draw 
gold  from  other  countries. 

This  will  tend  to  deplete  the  bank  reserves  of  those 
countries  in  relation  to  circulating  bank  credit.  Either 
the  gold  will  come  directly  from  these  bank  reserves  as 
when  it  is  drawn  from  the  great  central  banks  of  Europe 
for  export,  or  it  will  come  indirectly  but  just  as  surely 
from  bank  reserves,  as  when  gold  is  bought  for  export 
from  a  United  States  subtreasury  and  is  paid  for  by 
lawful  money  which  might  otherwise  be  used  as  reserves.2 

turn  flow.  Yet  so  unprecedented  a  movement  as  the  recent  one  here  under 
discussion,  might  conceivably,  if  met  only  by  a  rise  in  the  discount  rate  (which 
would  also  have  to  be  great  and  sudden),  dangerously  and,  considering  the 
probable  temporary  nature  of  the  crisis,  unnecessarily  disturb  credit  conditions. 

1  Cf.  Fisher,  The  Purchasing  Power  of  Money,  New  York  (Macmillan),  1911, 
p.  267. 

*  Even  if  the  gold  is  purchased  with  bank  credit,  the  reserves  become  smaller 
in  proportion  as  compared  with  the  total  amount  of  such  credit ;  and  they  tend 
(since,  as  we  have  seen  —  Ch.  II,  §  5  —  business  men  keep  some  relation  between 
their  bank  accounts  and  cash  assets,  and  will  draw  out  cash  if  the  latter  become 
relatively  too  small)  to  become  absolutely  smaller. 


138  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


The  conclusion  is  that  in  any  case  the  banks  in  those 
countries  from  which  the  gold  is  drawn,  will  also  have 
occasion  to  raise,  somewhat,  their  discount  rates,  in  order 
to  keep  their  reserves  and  their  deposits  (and  notes) 
in  proper  relation  to  each  other.  And  if  contraction  of 
credit  causes  a  fall  of  prices  in  one  country,  the  mitigated 
effect  of  this,  at  least,  must  spread  to  other  countries. 
It  does  not  follow  that  a  severe  panic  in  one  country 
must  be  accompanied  by  or  succeeded  by  a  correspond¬ 
ingly  severe  panic  in  others ;  but  only  that  in  each  of 
a  group  of  commercially  related  countries  there  will 
be  practically  simultaneous  rises  in  price  levels,  nearly 
simultaneous  high  prices  and  high  discount  (interest) 
rates,  and  substantially  simultaneous  decline.  The 
goodness  of  its  banking  system  (and  other  facts),  may 
make  the  changes  more  gradual  and  less  severe  in  one 
country  than  in  others,  but  is  not  likely  to  prevent  the 
changes  altogether. 

§6 

Exchange  between  Two  Countries  when  One  has  a  Gold 
and  the  Other  a  Silver  Standard 

An  excess  production  of  gold  in  any  country  raises 
prices  there  compared  to  prices  in  other  countries, 
encourages  buying  goods  in  other  countries,  and  there¬ 
fore  raises  the  rate  of  exchange  on  other  countries. 
Export  of  gold  follows.  The  introduction  of  a  cheaper 
standard  of  value  has  the  same  effect.  A  large  coinage 
of  cheaper  money,  e.g.  silver  at  a  ratio  of  16  to  i  (which 
would  greatly  overvalue  silver  and  lead  to  a  large  coin¬ 
age),  would  increase  M .  Prices  would  rise  and  the  value 
of  money  would  fall.  Goods  would  therefore  be  pur¬ 
chased  abroad.  The  rate  of  exchange  on  foreign  coun- 


FURTHER  CONSIDERATIONS  ON  EXCHANGE  139 


tries  would  rise  and  gold  would  be  exported.  As  long 
as  the  silver  and  gold  both  circulated  and  were  generally 
acceptable  for  goods  at  the  legal  ratio,  the  rate  of  ex¬ 
change  would  not  rise  much  above  the  gold  export 
point.  But  if  this  ratio  encouraged  the  continued  coin¬ 
age  of  silver,  the  gold  would  eventually  be  entirely 
driven  out  of  the  currency  of  the  silver  coining  country. 
Then  the  rate  of  exchange  would  rise  even  higher,  for 
prices  in  the  silver  country  would  continue  to  rise  until 
silver  coin  had  no  greater  value  than  silver  bullion.  But 
once  the  gold  had  been  entirely  driven  out,  there  could 
be  no  further  effect  on  the  amount  of  money  and  there¬ 
fore  on  prices,  in  other  countries,1  produced  by  the  coin¬ 
age  of  silver.  Consequently,  the  prices  of  the  silver 
country  would  be  permanently  higher  than  formerly, 
compared  to  prices  abroad,  and  its  money  standard  of 
less  value.  Instead  of  the  rate  of  exchange  on  England, 
supposing  the  United  States  to  be  the  silver  standard 
country,  averaging  $486.65  =  £100,  it  might  average 
$973-3°  —  £i°°,  °r  some  other  new  and  higher  rate. 
The  rate  of  exchange  would  have  risen  tremendously. 
In  fact,  such  a  rise  in  the  rate  of  exchange  is  good  evi¬ 
dence  of  a  cheaper  or  depreciated  currency.  But  the 
rate  of  exchange,  though  in  figures  much  higher  than 
before,  would  not  necessarily  be  above  par.  Instead, 
there  would  be  a  new  par.  $973.30  =  £100  might  have 
become  this  par.  Exchange  would  thereafter  fluctuate 
about  this  new  instead  of  about  the  old  and  lower  par. 

Par  of  exchange  would  no  longer  be  steady.  For  with 
one  country  on  a  silver  standard  and  the  other  on  a  gold 
standard,  the  monetary  unit  of  one,  e.g.  the  dollar,  would 
have  no  fixed  relation  to  the  monetary  unit  of  the  other, 

1  See,  however,  remainder  of  this  section  (6). 


140  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


e.g.  the  pound.  The  value  ratio  of  these  units  would 
vary  with  the  value  ratio  in  the  bullion  markets,  of  sil¬ 
ver  and  gold.  But  exchange  in  neither  country,  on  the 
other,  could  go  above  par  by  much  more  than  the  cost 
of  shipping  specie.  Exchange  in  the  silver  standard 
country  on  the  gold  standard  country,  would  be  limited 
by  the  cost  of  gold  in  terms  of  silver,  plus  the  cost  of 
shipment.1  Vice  versa,  exchange  in  the  gold  country  on 
the  silver  country,  could  not  go  higher  than  the  cost  of 
silver  in  terms  of  gold,  plus  the  cost  of  shipment. 

How  would  trade  balance  when  there  was  no  longer, 
between  two  such  trading  countries,  the  influence  of  price 
relations  in  the  same  precious  metal,  to  make  the  flow 
of  goods  one  way  balance  a  return  flow  ?  The  balance 
might  then  be  brought  about  by  the  flow  of  gold  one  way, 
and  of  silver  the  other.  If  we  should  for  a  time  buy  more 
in  England  than  the  English  of  us,  and  had  a  net  indebted¬ 
ness  to  meet,  we  might  purchase  gold  in  the  bullion 
market  here,  with  which  to  settle.  This  (assuming  the 
United  States  to  be  on  a  silver  standard)  would  not 
directly  affect  our  prices,  but  would  increase  the  quantity 
of  money  and  tend  to  raise  prices  in  England.  In  this 
country  it  would  tend  to  make  gold  bullion  scarce  and  dear 
as  compared  with  our  silver  money  and  with  other  goods. 
A  given  amount  of  English  money  would  buy  more 
American  dollars  than  before,  and  would  buy  more 
American  goods  than  before,  as  compared  with  the  goods 
it  would  buy  in  England.  That  is,  par  of  exchange  in 
England  on  the  United  States  would  be  lower.  There 
would  also,  of  course,  be  some  tendency  for  prices  in  one 
country  to  fall  and  in  the  other  to  rise  because  of  the  flow 

1  Goschen,  The  Theory  of  the  Foreign  Exchanges,  pp.  76-81 ;  cf.  Clare,  The 
A.B.C.  of  the  Foreign  Exchanges,  London  (Macmillan),  1893,  pp.  139-142.  * 


FURTHER  CONSIDERATIONS  ON  EXCHANGE  141 


of  goods  as  well  as  because  of  the  flow  of  money.  The 
greater  supply  of  goods  in  the  importing  country,  the 
United  States,  in  relation  to  money,  would  tend  to  lower 
the  price  level;  while  the  outflow  of  goods  from  the 
exporting  country,  England,  would  tend,  there,  to  raise 
the  price  level. 

The  fact  that  a  given  amount  of  English  money  would 
buy  more  American  goods  than  before,  would  encourage 
English  buying  here;  while  the  less  purchasing  power 
over  English  goods,  of  American  money,  would  dis¬ 
courage  American  buying  in  England.1  Hence  trade 
would  reach  equilibrium  or  would  flow,  for  a  time,  in  the 
opposite  direction.2  Exchange  in  England  on  the  United 
States  would  rise  above  par,  and  specie  would  be  shipped. 

If  exchange  on  England  should  be  below  par  and  the 
flow  of  specie  should  be  from  them  to  us,  the  same  prin¬ 
ciple  would  apply.  The  silver  sent  to  us  in  settlement 
of  balances  would  tend  to  raise  our  prices  and  lower 
the  value  of  silver  in  the  United  States.  Its  exportation 
from  England  would  tend  to  make  silver  in  England 
relatively  scarce  and  dear.  As  a  consequence,  a  given 
number  of  American  dollars  would  buy  more  pounds  than 
before  and  would  buy  more  goods  in  England  than 


1  Cf.  Bastable,  The  Theory  of  International  Trade,  fourth  edition,  London 
(Macmillan),  1903,  pp.  59,  60.  See  also  Professor  Marshall’s  “memorandum” 
on  the  effect  in  international  trade  of  different  currencies,  Appendix  to  Final 
Report  of  the  Gold  and  Silver  Commission,  1888,  pp.  47-53. 

2  If  we  suppose  American  silver  exported  to  buy  English  gold  for  settling 
the  balance  against  us,  because  of  a  more  favorable  price  of  gold  in  England  com¬ 
pared  to  silver,  we  shall  nevertheless  reach  the  same  final  conclusion.  On  this 
supposition,  the  outflow  of  silver  would  tend  to  lower  American  prices,  raising 
here  the  value  of  silver.  In  England,  silver  would  become  of  less  value  in  com¬ 
parison  with  gold.  A  given  sum  of  English  money  would  buy  more  American 
money,  and  would  buy  more  American  goods  than  before  as  compared  with  the 
goods  it  would  buy  in  England.  Therefore,  the  flow  of  trade  must  reach  equilib- 
rium  or  even  be  temporarily  reversed. 


142  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


before  as  compared  to  what  they  would  buy  here.  The 
surplus  flow  of  goods  from  the  United  States  to  England 
would,  other  things  equal,  be  brought  to  an  end.  If, 
therefore,  two  trading  countries  have,  respectively,  a 
silver  and  a  gold  standard,  the  laws  of  trade  between  them 
are  not  greatly  different  than  if  both  have  the  same 
standard.  It  is  still  true  that  each  will  buy  goods  of  the 
other ;  and  it  is  still  true  that  an  excess  flow  of  trade  in 
one  direction  tends  so  to  change  monetary  and  price 
conditions  as  to  bring  its  own  termination. 

§7 

Exchange  between  Two  Countries  when  One  has  a  Gold 
and  the  Other  an  Inconvertible  Paper  Standard 

Let  us  now  suppose  the  case  of  a  paper  standard,  i.e. 
paper  money  not  redeemable  in  specie,  in  one  of  two 
trading  countries,  and  a  gold  standard  in  the  other,  as 
with  the  United  States  and  England  during  our  Civil 
War  period.  The  rate  of  exchange  in  the  paper  money 
country  on  the  other,  would  depend  chiefly  on  the  cost 
of  gold  in  terms  of  paper,  and  therefore  would  rise  as  the 
paper  money  depreciated  in  relation  to  gold.1  Thus, 
during  the  Civil  War,  exchange  in  the  United  States  on 
other  countries,  e.g.  England,  rose  to  a  very  high  figure, 
because  of  the  depreciation  of  the  greenbacks.  Con¬ 
versely,  the  rate  of  exchange  in  the  gold  standard  country 
on  the  country  with  a  paper  standard  would  depend 
mainly  on  the  cost  of  this  paper  money  in  terms  of  gold, 
and  therefore  would  fall  as  the  paper  money  depreciated.2 
In  the  paper  money  country,  the  upper  limit  of  exchange 
on  the  other  cannot  much  exceed  the  cost  of  purchasing 

1  Goschen,  The  Theory  of  the  Foreign  Exchanges ,  pp.  69, 


1 Ibid . 


FURTHER  CONSIDERATIONS  ON  EXCHANGE  143 


gold  with  paper,  plus  the  cost  of  shipping  the  gold.1 
If  we  regard  exchange  between  two  such  countries  as  at 
par  (though  the  paper  money  might  be  depreciated  far 
below  par)  when  the  money  of  the  paper  standard  coun¬ 
try  will  buy  just  as  much  exchange  on  the  gold  standard 
country  as  it  will  buy  gold  at  home,2  then  we  may  say 
that  exchange  could  rise  above  par  by  the  cost  of  shipping 
specie.3  In  general,  we  may  say  that  exchange  might 
either  rise  above  or  fall  below  this  par,  by  the  cost  of 
specie  shipment,  just  as  it  might  rise  above  or  fall  below 
par  by  the  cost  of  specie  shipment  if  both  countries  had 
the  same  specie  as  standard. 

When  one  of  two  countries  has  inconvertible  paper  and 

1 Ibid . 

‘This  is  the  logical  though  not  the  ordinary  use  of  the  word  “par”  in  re¬ 
lation  to  exchange,  when  one  country  has  a  depreciated  currency.  It  is  custom¬ 
ary  to  regard  as  par  what  would  be  par  if  there  were  no  depreciation.  Strictly 
speaking,  however,  the  departure  from  this  rate,  due  to  depreciation,  means  a 
departure  of  the  money  from  par,  rather  than  of  exchange. 

*  This  is  not  inconsistent  with  Bastable’s  statement  ( Theory  of  International 
Trade ,  pp.  87,  88)  regarding  the  possible  rise  of  the  exchanges  on  other  countries, 
in  a  country  having  an  inconvertible  but  not  depreciated  paper  money.  In 
such  a  case,  it  is  said,  if  a  sudden  demand  for  exchange  and,  consequently,  for 
gold  to  export,  is  coincident,  in  the  paper  money  country,  with  a  temporarily 
inadequate  supply  of  gold,  exchange  may  rise  above  the  usual  specie  shipping 
point.  But  though  the  rate  may  go  up  beyond  the  usual  shipping  point,  it  can 
hardly  be  said  to  do  so  if  the  paper  money  is  in  no  sense  depreciated.  Though 
the  paper  money  may  not  have  depreciated  in  relation  to  goods  in  general, 
and  may  not  have  depreciated,  permanently,  in  relation  to  gold,  yet,  for  the  time 
being,  it  has  depreciated  compared  to  gold  in  the  paper  standard  country.  Under 
such  circumstances,  however,  it  may  fairly  be  emphasized  that  the  rise  of  ex¬ 
change  is  due  rather  to  a  local  rise  in  the  value  of  gold  than  to  a  fall  in  that  of 
the  paper. 

A  special  case  discussed  by  Goschen  ( The  Theory  of  the  Foreign  Exchanges , 
pp.  70-72),  is  that  of  a  country  which,  having  an  inconvertible  paper  money, 
has  also  forbidden  the  export  of  the  precious  metals.  In  such  a  country,  exchange 
on  others  cannot  be  prevented,  by  shipment  of  specie,  from  rising  above  the 
gold  shipping  point,  since  the  law  forbids  such  shipment.  Except  as  the  law 
may  be  evaded,  a  rising  exchange  rate  can  then  only  be  limited  by  a  retardation 
of  imports  and  a  stimulation  of  exports  (see  §  9  of  this  chapter)  or,  for  a  time,  by 
borrowing  from  abroad  (see  Goschen,  Foreign  Exchanges,  loc.  cit.). 


144  THE  EXCHANGE  MECHANISM  OF  COMMERCE 

1 

the  other  a  gold  standard,  the  effect  on  prices,  produced 
by  the  flow  of  specie  consequent  on  trade  between  them, 
could  occur  only  in  the  gold  standard  country.  When 
the  paper  standard  country  has  a  balance  to  pay,  gold 
may  be  purchased  with  this  paper  money  and  exported 
(or,  which  for  purposes  of  our  discussion  amounts  to  the 
same  thing,  imported  by  the  gold  standard  country). 
This  will  raise  prices  in  the  gold  standard  country  to 
which  the  gold  flows.  If  the  trade,  however,  is  between 
a  paper  standard  country  and  several  gold  standard 
countries,  the  effect  on  the  latter  will  be  more  diffused 
and  their  prices  raised  but  slightly.  But  the  outflow 
of  gold  bullion  from  the  paper  standard  country  will 
tend,  if  long  continued,  to  make  gold  in  that  country 
scarce  and  dear  in  relation  to  other  desired  goods.  A 
given  amount  of  gold  will  buy  not  only  more  paper 
money,  but  also  more  of  other  goods  than  before.  Drafts 
drawn  on  the  gold  standard  country,  or  remitted  by  its 
people,  in  payment  for  goods  purchased  in  the  paper 
standard  country,  will  represent  less  gold  than  previously 
for  the  same  goods  bought.  Therefore,  more  goods 
will  be  purchased  in  the  paper  standard  country  by  the 
people  of  the  other,  and  gold  will  flow  back  again  to 
the  former  country.  This  tendency  is  accentuated  by  the 
flow  of  goods.  If,  at  first,  goods  are  imported  by  the 
paper  standard  country,  the  larger  supply  of  goods  in  that 
country,  relative  to  the  paper  money  and  to  gold ,  tends 
to  make  the  prices  of  these  goods  lower  in  either  standard. 
In  the  exporting  country,  relative  scarcity  of  goods  tends 
to  make  prices  somewhat  higher  measured  in  gold. 
Hence,  for  this  reason  also,  more  goods  are  bought  with 
gold  in  the  paper  standard  country,  and  gold  tends  to 
flow  to  that  country. 


FURTHER  CONSIDERATIONS  ON  EXCHANGE  145 

§8 

Exchange  between  Two  Countries  when  Both  have  In¬ 
convertible  Paper  Standards 

Suppose,  next,  that  there  is  in  each  of  two  trading 
countries  an  inconvertible  paper  standard.  Then  the 
rate  of  exchange  in  either  upon  the  other,  so  long  as  gold 
is  the  medium  for  settling  international  balances,  will 
depend  on  the  value  of  both  currencies  in  relation  to  gold. 
Suppose  the  two  countries  to  be  the  United  States  and 
France.  Then,  in  the  United  States,  exchange  on  France 
would  rise  if  American  money  depreciated  compared 
to  gold  (French  money  remaining  the  same),  or  if  French 
money  appreciated  in  relation  to  gold  (American  money 
remaining  the  same),  or  if,  simultaneously,  American 
money  depreciated  and  French  money  appreciated.  The 
same  causes  would  make  exchange  in  France  on  the 
United  States  fall.  The  rise  in  exchange  on  France 
and  the  fall  in  exchange  on  the  United  States  would  be 
limited  by  the  depreciation  of  the  American  money 
plus  the  appreciation  of  the  French  money,  plus  the  cost 
of  specie  shipment.  For  if  American  money  depreciated 
one-half  compared  to  gold,  exchange  on  France  (excluding 
the  cost  of  gold  shipment)  would  double,  since  it  would 
take  twice  as  many  American  dollars  to  buy  the  same 
amount  of  gold  for  shipment  to  France,  and,  therefore, 
to  buy  the  gold  equivalent  of  a  certain  number  of  francs. 
Likewise,  if  French  money  doubled  in  value  in  relation 
to  gold,  exchange  on  France  would  double,  since  it  would 
take  twice  as  many  dollars  as  before  to  buy  the  double 
amount  of  gold  which  was  now  the  equivalent  of  a  given 
number  of  the  doubled  value  francs.  Above  this 
amount,  exchange  could  rise  by  the  cost  of  shipping  gold. 


146  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


Under  the  assumed  circumstances,  the  currencies  of 
the  two  countries  would  be  unrelated  to  each  other.  No 
amount  of  buying  by  the  merchants  of  the  United  States, 
in  France  could,  through  a  flow  of  money,  lower  Ameri¬ 
can  or  raise  French  prices,  for  American  money  would 
not  be  legal  tender  in  France  or  (being  paper)  of  any 
intrinsic  value  there.  Neither  could  French  buying  in 
the  United  States  produce,  by  the  flow  of  money,  the 
reverse  consequence.  How,  then,  would  excess  buying 
by  one  country  in  the  other  eventually  cause  more 
buying  by  the  second  in  the  first?  It  would  have  this 
effect  through  the  flow  of  gold  and  the  consequent  influ¬ 
ence  on  the  value  of  gold  in  the  two  countries ;  and  also 
through  the  flow  of  goods  and  the  effect  of  that  flow  on 
prices  in  the  two  countries  and  so  on  the  relative  values 
of  gold,  in  both  countries,  in  relation  to  goods. 

If  the  United  States  should  buy  more  of  France  in  any 
period  than  it  sold  to  France,  gold  would  flow  to  France. 
Gold  would  therefore  come  to  have  more  value  in  the 
United  States,  where  it  was  scarce,  and  less  value  in 
France,  than  before.  A  given  number  of  francs  would  buy 
more  gold,  and  a  given  amount  of  gold  would  buy  more 
dollars.  Par  of  exchange,  in  the  sense  here  used,  would 
be  lower  in  France  on  the  United  States,  and  higher  in 
the  United  States  on  France.  This  means  that  in  terms 
of  French  money,  goods  could  be  purchased  in  the  United 
States  more  cheaply  than  before;  while  in  terms  of 
American  money,  French  goods  would  be  more  expensive 
than  before.  As  a  consequence,  the  French  would  buy 
more  American  goods,  and  Americans  would  buy  less 
French  goods;  the  rate  of  exchange  in  France  on  the 
United  States  would  rise  above  this  low  par,  and  in  the 
United  States  on  France  it  would  fall;  and  gold  would 
flow  back  from  France  to  the  United  States. 


FURTHER  CONSIDERATIONS  ON  EXCHANGE  147 


In  addition,  if  the  United  States  should  buy  a  net 
balance  of  goods  from  France,  in  any  period,  this  would 
tend  to  make  goods  more  plentiful  in  the  United  States 
and  less  so  in  France,  in  relation  to  gold,  so  that,  for  this 
reason  also,  it  would  become  more  profitable  than  before 
to  send  gold  from  France  to  the  United  States  for  goods. 

§  9 

Exchange  between  Two  Countries,  Assuming  Effective 
Prohibition  of  Specie  Shipment 

So  far  we  have  assumed,  even  when  discussing  trade 
between  countries  having  unrelated  currencies,  that  gold 
or  silver  would  be  used  to  settle  international  balances. 
But  suppose  that  the  mediaeval  theory  of  prohibiting 
the  export  of  specie  were  still  in  vogue  and  were  com¬ 
monly  applied.  Would  there  be,  then,  any  limits  to  the 
fluctuations  of  exchange  (assuming  obligations  still  to 
be  settled  by  using  drafts),  and  would  there  still  be  a 
tendency  for  the  trade  in  opposite  directions,  to  balance  ? 
Under  usual  existing  conditions,  the  fluctuations  of  ex¬ 
change  with  any  country  are  limited,  as  we  have  seen, 
by  the  cost  of  shipping  specie.  Any  further  rise  or  fall 
is  checked  by  specie  shipment  and  by  the  consequent 
effect  on  supply  of  drafts,  or  demand  for  them,  or  both. 
But  if  specie  shipment  were  prohibited,  and  prohibited 
at  all  effectively,  the  limits  to  exchange  fluctuations  could 
not  be  so  narrow.  The  rate  of  exchange,  for  example, 
in  the  United  States  on  England,  if  the  balance  of  obliga¬ 
tions  were  markedly  in  England’s  favor,  could  then  go 
considerably  above  $488.65  without  at  once  increasing 
the  supply  of  or  decreasing  the  demand  for  drafts  on 
England,  to  such  an  extent  as  to  stop  the  rise.  Since 


148  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


gold  could  not  be  exported,  Americans  owing  money  in 
England  would  have  to  settle  by  remitting  drafts  or  by 
redeeming  drafts  drawn  against  them.1  In  the  latter 
case,  American  banks  must  purchase  drafts  on  England 
in  order  to  settle  with  correspondents,  since  the  alterna¬ 
tive  of  shipping  specie  is  excluded.  Drafts  on  England 
might,  therefore,  sell  at  a  rate  which  American  debtors 
and  debtor  banks  would  refuse  to  pay  if  they  had  the 
forbidden  alternative. 

Yet  there  would  still  be  limits,  though  wider  and 
perhaps  less  definite  ones,  to  the  fluctuations  in  the  price 
of  drafts.  The  high  price  of  drafts  on  England  would 
encourage  and  stimulate  the  sale  of  American  goods  in 
England  and  would  discourage  buying  goods  from  Eng¬ 
land.  Goods  which  would  bring,  in  England,  say  £100, 
but  which  would  not  ordinarily  be  sent  there  for  sale, 
because  that  sum  yielded  no  profit,  might  be  exported  if 
a  draft  on  England  for  £100  would  sell,  here,  for  $495. 
And  the  sale  of  goods  in  England,  thus  stimulated,  would 
tend,  by  increasing  the  supply  of  drafts  on  England,  to 
prevent  further  rise  in  the  prices  of  such  drafts.  Also, 
goods  which  could  be  purchased  in  England  for  £100 
and  which,  if  $486.65  would  buy  a  draft  for  £100  and 
so  would  pay  for  the  goods,  would  be  bought  in  England, 
very  probably  would  not  be  bought  if  the  draft  necessary 
to  pay  for  them  cost  $495. 

Conversely,  even  though  exchange  on  England  fell 
below  the  gold  shipping  point,  because  of  a  net  balance 
owing  from  England  to  us,  combined  with  an  English 
prohibition  on  the  outflow  of  gold  from  England,  such  a 
fall  in  exchange  would  not  be  without  limit.  For  it 

1  Renewal  of  credit,  use  of  finance  bills,  etc.,  would  of  course  serve  as  tempo¬ 
rary  expedients  to  postpone  settlement. 


FURTHER  CONSIDERATIONS  ON  EXCHANGE  149 


would  encourage  buying  in  and  discourage  selling  to 
England.  Goods  which  could  be  sold  in  England  for 
£100  and  which  it  would  ordinarily  pay  to  ship  there, 
it  might  not  be  profitable  to  ship  if  a  draft  on  London 
for  £100  would  only  realize,  in  New  York,  $460  or  less. 
The  consequent  refusal  to  ship  goods  to  England  would 
tend  to  decrease  the  supply  of  drafts  on  England  and  to 
prevent  further  fall  in  their  prices.  At  the  same  time, 
it  might  become  more  profitable  for  us  to  buy  goods  in 
England,  paying  for  these  goods  by  purchasing  and 
mailing  the  low-priced  London  drafts  and  so  adding  to 
the  demand  for  such  drafts. 

During  the  summer  and  fall  of  this  year  (1915)  drafts 
on  the  principal  European  belligerent  countries  have 
been  selling  at  rates  far  below  the  ordinary,  gold-ship¬ 
ping  points.  Sight  drafts  on  London,  for  instance, 
have  sold  at  4.70,  at  4.60,  even  at  4.50,  and  correspond¬ 
ing  discounts  have  ruled  with  respect  to  other  European 
centers.  It  would  seem  that  these  discounts  cannot 
be  sufficiently  explained  by  citing  the  war  risk  of  gold 
shipment,  since  war  risk  insurance  is  but  1  per  cent  in 
British  bottoms  and  in  American  vessels  is  even  less. 
This  risk,  in  addition  to  the  ordinary  cost  and  risk  of 
shipment,  might  account  for  a  rate  on  London  as  low 
as  4.80  or  4.79,  but  hardly  for  a  rate  much  lower.  There 
seems  no  escape  from  the  conclusion  that  interference 
with  gold  exports  from  the  countries  at  war  is  an  im¬ 
portant  factor  in  the  problem.  Such  interference  there 
has  been  and  is.1  For  example,  France  has  forbidden 

xThe  more  important  commercial  countries  engaged  in  the  present  war, 
e.g.  Great  Britain,  France,  and  Germany,  would  appear  thus  far  (October,  1915) 
to  have  been  successful  in  preventing  depreciation  of  their  paper  money,  in  the 
commonly  understood  sense  of  depreciation  in  relation  to  gold.  The  success 
which  they  have  had  in  this  direction  is  probably  due,  in  considerable  measure. 


150  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


any  person  other  than  the  Bank  of  France  to  export 
gold,  and  the  Bank  of  France  is  controlled  by  the  govern¬ 
ment,  which  appoints  its  manager.  Great  Britain  has 
not  formally  prohibited  the  export  of  gold ;  but  probably 
no  English  bank  would  venture,  under  existing  circum¬ 
stances,  to  export  gold  without  the  approval  of  the 
Bank  of  England,  and  the  Bank  of  England  will  arrange 
for  the  export  of  so  much  gold  only  as  its  officials  and 
the  government  think  may  wisely  be  parted  with. 
Hence  the  ordinary  free  flow  of  gold  has  ceased,  price 
levels  in  America  and  in  Europe  are  not  closely  related 
through  such  a  flow,  and  exchange  rates  can  fall,  and 
have  fallen,  far  below  par.  To  such  an  extent  has  this 
occurred  that  we  should  perhaps  soon  cease  to  find  it 
profitable  to  sell  food  supplies,  munitions,  etc.,  to  the 
Entente  Allies,  had  they  not  arranged  to  correct  mat¬ 
ters,  in  part,  by  borrowing  of  us  heavily  through  the 
sale  of  their  bonds  in  the  United  States. 

When  balances  are  habitually  settled  by  the  shipment 
of  gold  (or  other  precious  metals),  as  in  modern  trade, 
the  limits  of  fluctuation  in  exchange  are  narrow  because 
gold,  having  large  value  in  small  bulk,  can  be  shipped 
for  a  small  per  cent  of  its  value.  An  excess  of  trade 
in  one  direction,  therefore,  acts  largely  through  a  flow 
of  gold  as  an  intermediate  cause,  in  bringing  about  a 
balancing  flow  of  trade  in  the  contrary  direction.  This 
flow  of  gold  affects  prices  in  both  countries,  if  both  have 
the  gold  standard.  In  any  case,  it  affects  the  relative 

to  the  fact  that  they  will  not  allow  gold  to  be  exported.  They  have  thus  nar¬ 
rowed  the  market  for  gold  and  have,  in  effect,  cheapened  it  along  with  the 
paper.  Hence,  the  paper  money  may  not  appear  to  be  depreciated  even  though, 
in  the  sense  of  its  purchasing  power  over  goods,  it  is  so.  It  is  not  denied,  of 
course,  that,  under  all  the  circumstances,  a  belligerent  government  may  find  it 
desirable  to  husband  its  stock  of  gold  and  avoid,  if  possible,  any  depreciation 
of  the  sort  usually  meant  by  the  term. 


FURTHER  CONSIDERATIONS  ON  EXCHANGE  151 


purchasing  power  of  gold  in  these  countries,  and  the 
amount  of  goods  that  the  currency  of  the  one,  by  being 
first  exchanged  for  gold,  will  buy  in  the  other,  compared 
to  what  it  will  buy  at  home.  There  follows,  as  a  result 
of  this  change  in  relative  prices  or  in  relative  values  of 
the  two  money  standards,  a  change  in  the  flow  of  trade. 
This  change  in  the  flow  of  trade  is,  therefore,  in  large 
part,  but  an  indirect  consequence,  through  the  flow  of 
gold,  of  a  rising  or  falling  rate  of  exchange.  But  if  the 
flow  of  specie  is  effectively  prohibited,  and  the  fluctuations 
in  exchange  are,  in  consequence,  greater  (assuming  drafts 
to  be  still  used  as  the  chief  means  of  settling  obligations 
between  countries),  the  high  and  low  prices  of  drafts  will 
act  with  greater  force  directly  on  the  flow  of  trade. 

It  should  be  emphasized  that  high  and  low  exchange 
have  always,  to  some  extent,  this  direct  influence.  If  a 
draft  on  England  for  £100  will  sell  for  $488  in  New  York, 
it  may  be  profitable  to  export  goods  to  England  which  it 
would  not  pay  to  export  if  exchange  were  low.  Simi¬ 
larly,  if  drafts  on  England  for  £100  can  be  secured  for 
$484.70,  it  may  be  worth  while  to  buy  goods  there  which, 
if  exchange  were  higher,  would  not  be  purchased.  A  flow 
of  trade  in  one  direction  has  always,  then,  some  slight 
tendency  to  bring  about  its  own  termination  through 
affecting  the  rate  of  exchange,  and  thereby  the  direction 
of  trade.1  But  this  more  direct  influence  is  greater, 
because  the  possible  fluctuations  in  exchange  are  greater, 
if  and  when  specie  cannot  be  exported  from  either  of 
two  trading  countries.  Our  conclusion  is  that  whatever 
the  relation  of  the  currencies  of  two  trading  countries, 
and  whatever  the  mechanism  of  settling  balances,  or 
whatever  the  restrictions  on  settlement  by  the  use  of  any 

1  Cf.  Ch.  V.  (of  Part  I),  §  6. 


152  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


special  commodity,  e.g.  gold,  an  excess  flow  of  trade  in 
one  direction  introduces  always  a  tendency  towards  an 
opposite  and  balancing  flow. 

§  io 

The  Effect  on  the  Rate  of  Exchange  of  High  Import  and 

Export  Duties 

Let  us  now  give  very  brief  consideration  to  the  effects 
on  exchange  of  high  import  duties,  e.g.  the  so-called 
protective  tariff.  The  protective  tariff  is  a  high  tax  on 
imports,  intentionally  made  so  high  as  to  prevent  or 
decrease  imports,  and  encourage  buying  at  home. 
For  the  time  being,  the  country  adopting  such  a  policy 
will  export  an  excess,  the  rate  of  exchange  on  other  coun¬ 
tries  will  be  low,  and  specie  will  flow  in.  Then  prices 
rise  in  the  protectionist  country  in  relation  to  prices 
elsewhere,  exports  are  checked,  and  an  equilibrium  is 
reached ;  and,  in  the  absence  of  other  disturbing  causes, 
exchange  will  again  average  par. 

On  the  other  hand,  the  first  effect  of  a  high  tariff  on 
exports  would  be  to  decrease  exports.  For  a  while 
imports  would  be  in  excess.  Therefore,  the  rate  of 
exchange  would  rise.  Eventually  specie  would  flow 
out,  prices  would  fall,  imports  and  exports  would 
again  balance  (other  disturbing  factors  absent),  and 
there  would  no  longer  be  the  tendency  caused  by  excess 
imports  for  the  fall  of  prices  to  continue. 

§  ii 

Summary 

In  this  chapter  the  attempt  has  been  made  to  bring 
together  various  considerations  regarding  exchange, 


FURTHER  CONSIDERATIONS  ON  EXCHANGE  153 


which  seemed  to  have  no  proper  place  in  the  chapters 
preceding.  To  begin  with,  a  distinction  was  made 
between  sight  drafts  and  those  payable  some  time  after 
sight.  A  study  of  the  pure  rate  of  exchange  has  to  do 
only  with  the  former.  The  prices  of  the  latter  depend 
also  upon  the  rate  of  interest.  Two  possible  methods 
of  procedure  when  an  American  bank  invests,  for  the 
interest,  in  drafts  on  foreigners,  were  described.  It  was 
shown  that  the  prices  of  long  drafts  may  be  influenced 
by  the  rate  of  interest  in  the  drawing  and  in  the  accept¬ 
ing  country.  If  the  rate  of  interest  in  the  accepting 
country  is  the  lower,  this  rate  determines  the  prices  of 
long  drafts;  but  if  the  rate  of  interest  in  the  drawing 
country  is  the  lower,  purchase  of  the  drafts  by  investors 
or  investing  banks  in  that  country  may  make  these  drafts 
sell  for  somewhat  more  than  the  higher  rate  of  interest 
in  the  accepting  country  would  otherwise  allow. 

Consideration  was  given  to  the  influence,  on  the  pure 
rate  of  exchange  and  on  the  flow  of  specie,  of  changes  in 
interest  or  discount  rates  in  different  countries.  It  was 
seen  that  a  rise  of  the  bank  discount  rate  in  any  country 
tends  to  create,  elsewhere,  high  rates  of  exchange  on  that 
country  and  a  flow  of  specie  to  it.  But  it  was  also  seen 
that  the  chief  effect  of  such  a  rise  in  bank  discount  is  to 
check  undue  credit  expansion  or  reduce  excessive  credit. 
Only  as  it  has  this  effect,  will  the  inflow  of  specie  be  pre¬ 
vented  from  so  raising  prices  as  to  result  in  a  subsequent 
corresponding  outflow.  Since  interest  rates  and  prices 
in  different  countries  are  related,  it  follows  that  a  finan¬ 
cial  panic  in  one  country  must  produce  some,  though  per¬ 
haps  comparatively  mild,  effects  upon  other  countries. 

The  rates  of  exchange  between  countries  having  dif¬ 
ferent  monetary  standards  were  next  considered.  If 


154  THE  EXCHANGE  MECHANISM  OF  COMMERCE 


one  country  has  gold  and  another  silver,  exchange  can 
fluctuate  as  the  ratio  of  value  of  silver  to  gold  fluctuates, 
and,  in  addition,  by  the  cost  of  specie  shipment.  If  one 
country  has  gold  and  the  other  has  inconvertible  paper, 
exchange  in  the  latter  on  the  former  can  rise  (and  in  the 
former  on  the  latter,  fall)  by  the  amount  of  depreciation 
of  the  paper  in  terms  of  gold,  plus  the  cost  of  gold  ship¬ 
ment.  If  both  countries  have  inconvertible  paper,  ex¬ 
change  in  either  on  the  other  can  rise  by  the  amount  of 
depreciation  in  the  currency  of  the  first  plus  the  amount 
of  appreciation  in  that  of  the  second,  plus  the  cost  of 
specie  shipment.  Whatever  the  monetary  standard  or 
standards  of  trading  countries,  exchange  can  fluctuate 
beyond  the  above  assigned  limits,  if  the  movement  of 
specie  is  effectively  prohibited.  But  whatever  the 
standard  or  standards,  it  appeared  that  trade  cannot 
flow  continuously  in  one  direction  without  introducing 
a  tendency  to  a  reverse  flow.  By  acting  on  relative 
price  levels,  or  on  relative  values  of  currency  in  relation 
to  gold,  or  only  on  rates  of  exchange,  the  surplus  flow  in 
one  direction  will  eventually  bring  itself  to  an  end. 

Lastly,  brief  attention  was  given  to  the  effects  on 
exchange,  of  import  and  export  duties.  The  former  make 
exchange  on  other  countries  temporarily  lower.  The 
latter  make  it  temporarily  higher.  In  the  former  case, 
equilibrium  is  reached,  after  an  inflow  of  specie,  with  a 
higher  level  of  prices  in  the  country  levying  the  duties. 
In  the  latter  case,  when,  after  an  outflow  of  specie,  equi¬ 
librium  is  again  reached,  the  level  of  prices  in  the  duty- 
levying  country  is  lower. 


PART  II 


THE  ECONOMIC  ADVANTAGES  OF  COMMERCE 


CHAPTER  I 


Prices,  Intercommunity  Trade,  and  the  Gains  of 

Trade 


The  Relation  of  Prices  in  One  Country  to  Prices  in  Another 

Through  the  influence  of  trade,  the  price  in  any 
country  of  any  special  kind  of  goods  tends  toward 
equality  with  the  price  of  the  same  goods  in  other  coun¬ 
tries  with  which  the  first  one  trades.  Cost  of  carriage, 
of  course,  must  enter  into  the  selling  price  of  any  kind 
of  goods.  Due  to  the  natural  productivity  of  land, 
greater  efficiency  of  labor,  better  capital  equipment,  or 
other  cause,  some  goods  will  probably  be  produced  with 
less  relative  cost  in  one  country  than  in  the  others  trading 
with  it.  These  goods  will  tend  to  be  cheaper  in  the 
country  having  such  an  advantage,  and  to  be  sold  by  it 
to  the  others.  The  price  of  such  goods  in  the  other 
countries  cannot,  for  any  length  of  time,  be  higher  than 
in  the  exporting  country  by  much  more  than  the  expense 
of  transportation  or,  if  trade  is  restricted,  the  expense  of 
transportation  plus  tariff  charges ;  for  if  the  price  is  much 
higher,  none  of  the  goods  in  question  will  be  sold  in  the 
country  where  they  are  produced,  until  enough  has  been 
sent  abroad  to  more  nearly  equalize  prices.  Neither  can 
the  price  abroad  of  goods  produced  under  competitive 
conditions,  be  less  than  the  price  in  the  producing  country 

3 


4  ECONOMIC  ADVANTAGES  OF  COMMERCE 


plus  cost  of  transportation  and  tariffs,  if  any  of  the  goods 
at  all  are  sent  abroad.1 

To  illustrate,  suppose  a  certain  kind  of  cloth  to  be 
selling  at  wholesale  in  England  for  (the  equivalent  in 
English  money  of)  $i  per  yard.  Assuming  a  transporta¬ 
tion  and  tariff  expense  of  50  cents  a  yard,  it  would  sell 
in  Canada,  wholesale,  for  $1.50.  Suppose,  next,  that 
the  Canadian  demand  raised  the  Canadian  price  to 
$1.75  per  yard.  If  the  carrying  and  tariff  costs  remained 
at  50  cents,  and  the  Canadian  price  $1.75,  obviously  no 
one  would  sell  the  cloth  in  England  for  much  less  than 
$1.25.  If,  on  the  other  hand,  the  Canadian  demand 
should  decrease  so  that  the  cloth  could  not  be  sold 
in  Canada  for  more  than  $1.25,  then  none  of  this 
cloth  would  be  sent  from  England  to  Canada  unless 
the  English  price  fell  to  $0.75.  If,  because  the 
whole  supply  had  to  be  sold  in  England,  the  price 
should  fall  to  $0.75  per  yard,  a  surplus  might  be  ex¬ 
ported.  Otherwise,  it  would  pay  better  to  sell  all  the 
cloth  in  England. 

It  will  be  seen  that  the  general  level  of  prices  in  one 
country  is  not  by  any  means  necessarily  the  same  as  the 
price  level  in  the  other  countries  with  which  it  trades. 
If  we  imagine  two  countries  side  by  side,  with  no  tariff 
barriers  between  them,  and  with  a  zero  cost  of  transpor¬ 
tation  from  any  part  of  one  to  any  section  of  the  other, 
we  may  say  that  the  price  of  each  commodity  in  one 
country  must  equal,  measured  in  the  same  standard  of 
value,  its  price  in  the  other.  Obviously,  if  all  prices 

1  Except  as  goods  may  be  sold  cheaper  abroad  temporarily  in  order  to  de¬ 
velop  new  business,  and  for  other  special  reasons  of  very  limited  application. 
A  tariff  protected  monopoly  will  purposely  limit  its  sales  at  home  in  order  to 
realize  monopoly  profits,  while  selling  abroad,  where  competition  must  be  met, 
at  competitive  prices. 


INTERCOMMUNITY  TRADE 


5 


are  exactly  the  same,  then  the  general  average,  the  level 
of  prices,  must  be  exactly  the  same  in  one  country  as 
in  the  other.  In  comparing  the  price  levels  of  two 
countries,  we  may  take  as  a  unit  that  amount  of  each 
kind  of  goods,  in  one  of  the  countries,  which  sells  for  $i 
(or  £i  or  some  other  standard  monetary  unit).  The 
average  price  in  that  country  will  be  $i.  We  may  then 
learn  the  price  in  the  other  country,  of  each  such  unit 
amount  of  goods,  and  take  the  average  of  these  prices. 
This  gives  us  the  general  level  of  prices  in  the  second 
country  as  compared  with  that  of  the  first.1  The  most 
satisfactory  average  is,  of  course,  a  weighted  one,  i.e. 
an  average  in  which  each  kind  of  goods  is  given  an  im¬ 
portance  consistent  with  the  proportionate  value  of  it 
sold.  By  the  method  of  averaging  here  described,  it  is 
obvious  that,  given  costless  transfer  of  all  goods  and 
services,  the  average  price  or  price  level  in  the  one  coun¬ 
try  would  equal  the  average  in  the  other ;  for  all  prices 
would  be  exactly  the  same  in  each,  and  an  average, 
weighted  or  unweighted,  must  be  the  same. 

As  it  is,  however,  the  goods  which  are  the  special 
product  of  each  country  tend  to  be  lower  in  that  country, 
and  to  be  higher  in  other  countries,  by  an  amount  equal 
to  the  cost  of  transportation  and  other  obstacles  in  the 
way  of  trade.  This  makes  it  unlikely  that  the  average 
of  prices  in  one  country  will  be  the  same  as  the  average 
in  another  country.  Thus,  wheat  may  be  lower  in  price 
in  Canada  than  in  England  by  the  cost  of  transporta¬ 
tion.  At  the  same  time,  cotton  cloth  may  be  lower  in 
price  in  England  by  the  cost  of  transportation.  There 


1  Cf.  Fisher’s  suggestion  for  comparing  the  price  levels  in  the  same  country 
for  two  or  more  years,  Elementary  Principles  of  Economics,  New  York  (Macmil¬ 
lan),  1912,  p.  250. 


6  ECONOMIC  ADVANTAGES  OF  COMMERCE 


is  no  logical  reason  for  assuming  that  the  average  of 
prices  (the  level  of  prices)  is  the  same.  The  lower  priced 
wheat,  in  Canada,  may  conceivably  have  so  great  an 
importance  as  to  make  the  weighted  average  of  prices 
lower  there,  despite  the  higher  relative  price  of  cotton 
cloth.  Or  cotton  cloth,  cutlery,  shoes,  and  machinery, 
all  lower  in  England,  may  make  average  prices  lower 
there  even  though  wheat  is  lower  in  Canada.  Or  again, 
though  many  articles  may  be  lower  in  price  in  England, 
yet  these  may  be  for  the  most  part  such  things  as  houses, 
practically  non-transportable,  or  goods  transportable 
only  at  such  great  expense  as  generally  not  to  be  trans¬ 
ported.  A  few  things  may  be  lower  in  Canada  by  enough 
to  pay  for  shipment  to  England.  Under  these  circum¬ 
stances,  average  prices  will  certainly  be  lower  in  England 
although  trade  may  be  in  perfect  equilibrium.  A  dollar 
(or  its  mint  equivalent  in  English  money)  will  buy  more 
in  England,  yet  Canadian  money  will  not  flow  to  Eng¬ 
land  for  goods  transportable  at  great  expense,  in  any 
larger  quantity  than  English  money  will  flow  to  Canada 
for  a  few  goods  only  slightly  cheaper  in  Canada  but 
easily  transported.  Wheat  may  be  enough  lower  in 
Canada  to  pay  for  export,  and  cotton  cloth  enough  lower 
in  England.  Everything  else  may  be  lower  in  Eng¬ 
land,  yet  not  enough  lower  for  shipment  to  Canada. 
If  this  is  the  situation,  the  general  level  of  prices  in 
England  must  be,  and  must  remain,  lower  than  in 
Canada. 

But  though  the  price  levels  of  England  and  Canada 
are  not,  on  these  hypotheses,  the  same,  they  are  never¬ 
theless  related.  The  level  of  prices  in  England  may  be 
continuously  lower,  but  will  be  lower  only  to  a  certain 
extent.  A  rise  of  Canadian  prices  (the  result  of  gold 


INTERCOMMUNITY  TRADE 


7 


discoveries,  expansion  of  bank  credit,  inflow  of  gold 
from  the  United  States,  or  other  cause)  will  increase 
the  importations  by  Canada  from  England,  despite 
transportation  and  other  obstacles,  and  will  tend  to 
raise  English  prices  also,  thus  leaving  the  relation  between 
Canadian  and  English  prices  substantially  as  before. 
Similarly  a  rise  in  English  prices  will  affect  prices  in 
Canada ;  and  a  fall  of  prices  in  either  country  will  affect 
prices  in  the  other. 

§  2 

What  Prices  Tend  to  he  Lower  in  a  Given  Country ,  than 

Prices  of  the  Same  Kinds  of  Goods  in  Another 

Country 

It  is  apparent  that  prices  of  all  goods  are  not  likely 
to  be  lower  in  one  country  than  in  another  if  transporta¬ 
tion  and  tariff  conditions  are  such  as  to  make  any  appre¬ 
ciable  trade  profitable.  For  unless  the  cost  of  trans¬ 
portation,  plus  other  obstacles,  is  very  great,  the  low 
prices  in  the  one  country  will  cause  flow  of  gold  in  that 
direction.  This  will  continue  until  the  price  of  some 
good  or  goods  becomes  lower  in  the  previously  high  price 
country  than  in  the  other.1  The  condition  of  equilib¬ 
rium  will  be  realized  at  a  point  such  that  some  prices 
are  lower  in  the  one  country  and  some  lower  in  the  other. 
This  may  be  called  a  moving  equilibrium,  or  an  equi¬ 
librium  such  that,  other  things  equal,2  about  the  same 
value  of  trade  would  flow  in  each  direction. 

1  This  principle  is  expressed  with  great  clearness  in  Taussig’s  Principles  of 
Economics,  New  York  (Macmillan),  iqii,  Vol.  I,  pp.  486,  487. 

2  A  gold  mining  country  may  export  a  surplus  of  gold  and  import  a  surplus 
of  other  things,  but  exports  and  imports  as  a  whole,  none  the  less,  tend  to  be 
equal.  A  country  which  has  large  investments  abroad  will  usually  import 
more  than  it  exports  of  goods  in  general.  See  Part  I,  Ch.  V,  §  7. 


8  ECONOMIC  ADVANTAGES  OF  COMMERCE 


The  conclusion  that  some  prices  will  be  lower  in  one 
country  and  some  prices  in  others,  is  true  in  principle 
even  if  the  countries  trading  have  different  monetary 
standards,  e.g.  if  one  country  has  a  gold  and  the  other 
a  paper  standard.  We  saw,  in  the  last  chapter,  that 
whatever  the  relation  or  the  non-relation  of  the  monetary 
standards  of  two  countries,  trade  might  take  place  be¬ 
tween  them ;  and  that  the  flow  of  this  trade  in  one  direc¬ 
tion  would  tend,  in  the  long  run,  to  equal  the  flow  in 
the  other.1  Any  tendency  to  an  excess  flow  in  one  direc¬ 
tion  would  be  self-terminating.  When  the  position  of 
equilibrium  was  established,  some  prices  would  be  the 
lower  in  each  country  in  the  sense  that  the  money  of 
either  country  would,  through  the  process  of  gold  ship¬ 
ment  or  through  the  mechanism  of  the  exchanges,  buy 
more  of  some  goods  in  the  other  country  than  at  home. 

What  conditions  determine  which  prices  shall  be  lower 
in  one  country  than  in  another  or  others  ?  The  answer 
is:  those  goods  are  lower  in  price  in  any  country,  for 
the  production  of  which  it  has  relatively  great  advan¬ 
tages.  These  advantages  may  lie  in  geographical  posi¬ 
tion,  may  depend  upon  soil  and  climate  or  the  posses¬ 
sion  of  certain  mines  or  other  natural  resources,  or  may, 
in  certain  lines  of  activity,  depend  upon  high  acquired 
efficiency  of  labor.  Those  goods  in  the  production  of 
which  a  country  has  a  relative  advantage  and  which, 
therefore,  it  sells  at  a  low  money  price,  will,  of  course, 
assuming  trade  to  be  free,  be  the  things  it  exports.  The 
people  of  other  countries  will  avail  themselves  of  the 
opportunity  to  buy  these  goods  cheaply.  The  advan¬ 
tages  for  producing  them  will  mean  a  large  amount  of 
labor  and  capital  specializing  in  their  production  in  the 

1  See  Part  I,  Ch.  VI,  §§  6,  7,  8,  9. 


INTERCOMMUNITY  TRADE 


9 


exporting  country.  Since  the  low  prices  at  which  these 
goods  are  sold  result  from  the  relative  advantages  in 
that  country  for  their  production,  therefore  these  low 
prices  do  not  signify  that  the  industries  are  unprofitable. 
So  much  can  be  produced  with  a  given  amount  of  labor 
that,  even  at  low  prices,  the  yield  to  industry  is  high. 

Similarly,  the  existence  of  a  high  level  of  money  wages 
in  any  country,  does  not  mean  that  in  such  a  country 
some  goods  cannot  be  produced,  and  exported,  at  low 
money  cost.  The  United  States  may  have  money  wages 
twice  as  high,  per  day,  as  England.  Yet  if  the  American 
agricultural  laborer  can  produce  over  twice  as  much 
wheat  per  day,  because  of  the  extent  of  good  agricultural 
land,  as  can  be  produced  in  England  with  the  same  labor, 
then  the  money  cost  of  the  American  wheat  will  be  no 
greater  and  may  be  appreciably  less  per  bushel.  In 
selling  his  wheat  in  the  foreign  market,  the  farmer  is  not 
primarily  concerned  with  the  matter  of  how  much  he 
has  to  pay  his  men  by  the  day.  He  is  greatly  concerned 
with  the  matter  of  what  he  must  pay  them  per  bushel 
produced.  It  is  obvious,  therefore,  that  a  productive 
country  can  have  at  the  same  time  low  prices  of  goods 
which  it  exports,  and  high  wages  to  the  producers  of 
those  goods. 

Neither  is  it  essential,  in  order  for  a  country  to  export 
certain  goods  at  a  low  price,  that  it  should  be  able  to 
produce  those  goods  more  efficiently,  i.e.  with  less  labor 
expenditure,  than  other  countries.  All  that  is  neces¬ 
sary  is  that  for  the  production  of  such  goods,  its  disad¬ 
vantages  shall  be  less  than  for  the  production  of  other 
goods.  The  converse  of  this  proposition  is  that  all 
goods  will  not  necessarily  be  produced  at  the  lowest 
price,  in  the  country  where  they  can  be  produced  with 


io  ECONOMIC  ADVANTAGES  OF  COMMERCE 


least  labor.  Even  if  the  United  States  can  produce 
woolen  cloth  with  less  labor  expenditure  than  England, 
the  advantage  of  the  United  States  in  the  production 
of  steam  and  electric  engines  and  other  machinery,  may 
be  still  greater.  If  a  given  amount  of  labor  in  the  United 
States  will  produce  io  per  cent  more  woolen  cloth  or 
ioo  per  cent  more  engines  and  machinery  than  in 
England,  then  the  United  States  gains  more  by  produc¬ 
ing  the  engines  and  machinery  and  importing  the  cloth. 
The  price  at  which  producers  in  the  United  States  could 
afford  to  sell  machinery,  etc.,  would  therefore  be  com¬ 
paratively  low,  while  it  would  require  a  relatively  high 
price  of  woolen  cloth  to  induce  Americans  to  manufac¬ 
ture  it.  On  our  assumption,  American  labor  and  capital 
can  secure  more  money,  in  the  English  market,  for  the 
product  of  a  day’s  labor  in  making  machinery  than  for 
the  product  of  a  day’s  labor  in  a  cloth  factory,  and  still 
undersell  English  machine  makers.  On  the  other  hand, 
English  labor  and  capital  can  get  more  money  by  selling, 
in  the  United  States,  the  product  of  a  day’s  labor  in  the 
cloth  factory,  than  for  the  product  of  a  day’s  labor  in 
an  English  machine  making  factory,  and  yet  undersell 
American  cloth.  If  the  United  States  is  absolutely 
more  productive  in  both  lines,  as  well  as  in  most  or  all 
others,  it  might  be  better,  economically,  for  the  people  of 
England  to  migrate  to  the  United  States.  But  so  long 
as  they  choose  to  remain  in  England,  they  will  be  better 
off  if  they  specialize  in  the  production  of  cloth. 

It  appears,  therefore,  that  under  conditions  of  entire 
free  trade,  there  would  be  a  high  degree  of  geographical 
specialization ;  and  that  each  industry  would  be  located 
where  the  facilities  for  it  were  relatively  the  best,  all 
things,  including  transportation  cost,  considered.  In 


INTERCOMMUNITY  TRADE 


ii 


fact,  of  course,  the  location  of  industries  is  considerably 
affected  by  tariffs.  The  higher,  and  the  greater  in 
number,  are  these  trade  restrictions,  the  more  largely 
is  industry  turned  from  its  natural  channels.  If  there 
were  a  sufficiently  high  tariff  around  the  borders  of  Maine, 
cotton  could  perhaps  be  raised  in  Maine  hothouses. 
Similarly,  a  high  tariff  levied  by  South  Carolina  on  steel 
rails  brought  in  across  its  boundaries,  might  encourage 
the  manufacture  of  steel  rails  for  use  within  the  state, 
in  the  midst  of  the  South  Carolina  rice  fields,  with  iron 
brought  from  the  Lake  Superior  ore  regions  and  coal 
imported  from  Pennsylvania. 

§  3 

Trade  between  Two  Communities  when  Each  has  an  Ab¬ 
solute  Advantage  over  the  Other ,  in  One  or  More  Lines 
of  Production 

Let  us  now  illustrate  how  the  case  stands  as  to  prices 
and  gains  from  trade  when  two  communities  engage 
in  trade,  each  having  an  absolute  advantage  in  one  line 
of  activity  over  the  other.  We  shall  suppose  the  trade 
to  be  between  two  of  the  states  of  our  own  country, 
South  Dakota  and  Indiana.  South  Dakota  we  shall 
take  as  an  example  of  a  wheat-producing  section  and 
Indiana  as  an  example  of  a  corn-producing  section. 
Suppose  that  one  day’s  labor  in  South  Dakota,  of  one 
man,  produces  2  bushels  of  wheat  or  1  bushel  of  corn, 
while  in  Indiana  the  same  amount  of  labor  produces  1 
bushel  of  wheat  or  2  bushels  of  corn.  Assume,  also,  no 
cost  of  transportation  and  no  tariff  interferences  with 
trade.  If  wheat  sells  in  South  Dakota  for  $1  per  bushel, 
then  a  day’s  labor  in  the  wheat  fields  will  yield  $2.  No 


12  ECONOMIC  ADVANTAGES  OF  COMMERCE 

one,  therefore,  will  be  satisfied  to  produce  corn  in  South 
Dakota  for  less  than  $2  a  day.  But  since  only  1  bushel 
of  corn  can  be  produced,  $2  reward  will  necessitate 
a  price  of  $2  a  bushel.  Whatever  the  price  of  wheat, 
corn  must  sell,  if  produced  in  South  Dakota,  at  double 
that  price  per  bushel ;  and  therefore,  if  we  assume  $1 
per  bushel  for  wheat,  corn  must  sell  at  $2.  No  one 
in  South  Dakota  will  produce  it  for  appreciably  less. 
If  it  can  be  imported  for  less,  it  will  be. 

With  Indiana  the  case  is  reversed.  Corn,  by  our 
assumption,  is  produced  there  the  more  easily.  If  the 
corn  can  be  sold  for  $1  a  bushel,  it  will  give  producers 
$2  a  day.  Naturally  they  will  not  care  to  produce  wheat 
for  a  less  return,  and  therefore,  if  Indiana  is  less  adapted 
to  wheat  production,  they  must  get  a  higher  price  ($2 
a  bushel)  in  order  to  encourage  its  production  in  Indiana. 

Both  states  gain  by  the  trade.  South  Dakota  can 
produce  in  two  days’  labor,  2  bushels  of  wheat  at,  say, 
$1  per  bushel  and  1  bushel  of  corn  at  $2  a  bushel,  a  total 
of  3  bushels  or  $4  worth.  Indiana  can  produce  in  two 
days  of  labor,  1  bushel  of  wheat  at  $2  and  2  bushels  of 
corn  at  $1  a  bushel,  making  a  total  of  3  bushels  or  $4 
worth.  If  they  trade,  each  state  can  specialize.  South 
Dakota  can  produce  in  two  days  of  labor,  4  bushels  of 
wheat  at  $1  per  bushel,  or  $4  worth ;  while  Indiana  can 
produce  with  two  days  of  labor  available,  4  bushels 
of  corn  at  $1  each  or  $4  worth.  Trade  between  the 
two  states  will  make  it  possible  (assuming  an  even  ex¬ 
change)  for  each  state  to  get,  from  its  two  days  of  labor, 
2  bushels  of  corn  and  2  bushels  of  wheat,  instead  of 
2  of  one  cereal  and  1  of  the  other.  There  will  be  no  gain 
in  money  values.  In  either  case  the  total  is  $4  worth 
for  each  state.  But  there  will  be  a  considerable  differ- 


INTERCOMMUNITY  TRADE 


13 


ence  in  what  the  money  will  buy.  In  the  case  we  have 
assumed,  money  incomes  will  be  the  same  with  the  trade 
as  without  it,1  but  the  money  “cost  of  living”  will  be 
appreciably  reduced ;  $4  will  buy  a  total  of  4  bushels 
instead  of  only  3. 

It  is  clear  that,  under  our  assumed  conditions,  Dakota 
wheat  and  Indiana  corn  could  and  would  be  sold  the 
more  cheaply;  that,  therefore,  the  people  of  Indiana 
would  naturally  buy  Dakota  wheat  at  a  lower  price 
(e.g.  $1)  rather  than  Indiana  wheat  at  a  higher  ( e.g .  $2), 
while  the  people  of  South  Dakota  would  choose  to  buy 
corn  from  Indiana ;  also  that  this  arrangement,  so  obvi¬ 
ously  to  the  individual  interests  of  the  persons  concerned, 
would  make  both  states  the  richest.  Is  it  necessary 
to  point  out  that  what  is  true  as  regards  two  states,  terri¬ 
tories,  or  sections  under  the  same  general  government, 
is  also  true  of  two  different  nations?  If  Indiana  and 
South  Dakota  gain  by  such  a  trade  when  united  as  parts 
of  one  nation  by  the  government  at  Washington,  it  is 
reasonable  to  suppose  that  they  would  gain  in  just  the 
same  way  and  to  the  same  extent  if  each  were  a  separate 
nation.  And  in  an  exactly  analogous  way,  the  United 
States  gains  by  trade  with  Canada. 

§4 

Trade  between  Two  Communities  or  Countries  when  One 
is  More  Productive  than  the  Other  in  Several  or  in  All 
Lines ,  but  has  a  Greater  Advantage  in  One  Line  or  in 
a  Few  Lines  than  in  the  Rest. 

Let  us  next  illustrate  the  relations  of  money  prices, 
and  the  gains  from  trade,  when  one  country  or  community 

1  See,  however,  Ch.  IV  (of  Part  II),  §  2. 


i4  ECONOMIC  ADVANTAGES  OF  COMMERCE 


has  an  advantage  over  another  in  several  or  in  all  lines, 
but  a  greater  advantage  in  one  than  in  the  others.  As¬ 
sume  that  in  Canada  one  man’s  labor  for  a  week  will 
produce  20  bushels  of  wheat  or  14  yards  of  linen  cloth, 
while  in  Ireland,  a  week’s  labor  of  one  man  will  produce 
6  bushels  of  wheat  or  10  yards  of  cloth.  Ireland  is  at 
a  disadvantage  in  both  lines,  but  her  disadvantage  is 
less  in  linen  manufacture,  and  Canada’s  advantage  is 
greater  in  wheat  production.  Both  gain  if  Ireland  pro¬ 
duces  linen  and  Canada  produces  wheat  and  they  trade. 
Without  trade,  two  weeks  of  labor  in  Canada,  equally 
divided,  would  produce  20  bushels  of  wheat  and  14  yards 
of  linen.  In  Ireland,  two  weeks  of  labor  would  produce 
6  bushels  of  wheat  and  10  yards  of  linen.  Similarly, 
four  weeks  of  labor  in  Ireland  would  produce  12  bushels 
of  wheat  and  20  yards  of  linen.  Suppose,  now,  that  they 
trade,  and  that  a  bushel  of  Canadian  wheat  buys  a 
yard  of  Irish  linen.  Then  Canada  can  produce,  in  two 
weeks,  40  bushels  of  wheat,  and,  by  trading  half  of  it 
for  linen,  have  20  bushels  plus  20  yards,  instead  of  20 
plus  14.  Ireland  can  produce  in  two  weeks  20  yards  of 
linen,  or  in  four  weeks,  40  yards.  By  trading  half  of  this 
linen  for  wheat,  Ireland  will  have  20  yards  plus  20 
bushels  instead  of  20  plus  12,  as  a  reward  for  four  weeks’ 
work.  On  our  present  hypothesis,  Ireland  must  ex¬ 
change  the  product  of  two  weeks’  work  with  the  product 
of  one  week  of  work  in  Canada,  yet  gains  more  by  so 
doing  than  can  be  gained  by  refraining  from  the  exchange 
of  goods. 

That,  in  the  absence  of  trade  restrictions  or  excessive 
cost  of  transportation,  such  trade  will  automatically 
take  place,  becomes  evident  so  soon  as  we  ask  what 
prices  will  be  charged  by  the  producers  in  each  country. 


INTERCOMMUNITY  TRADE 


i5 

If  Canadians  are  able  to  produce  wheat  for  $1  a  bushel 
(and,  therefore,  $20  a  week),  they  will,  of  course,  be 
unwilling  to  produce  linen  for  any  smaller  weekly  re¬ 
turn,  i.e.  for  less  than  $20  for  14  yards,  or  $1.43  a  yard. 
If  linen  can  be  imported  from  Ireland  for  less  than 
$1.43,  say  for  $1  a  yard,  Canadian  wheat  producers 
will  buy  it  from  Ireland,  and  would-be  Canadian 
linen  manufacturers  will  find  more  profitable  employ¬ 
ment  in  wheat  raising. 

On  the  other  hand,  Irish  producers,  if  selling  linen  to 
Canada  at  $1  a  yard,  will  be  earning  only  $10  a  week, 
though  considerably  more  than  they  could  earn  produc¬ 
ing  6  bushels  of  wheat  at  $1  a  bushel.  To  induce  an 
Irish  linen  worker,  under  these  circumstances,  to  enter 
wheat  production,  would  require  $10  a  week  or  $1.67 
per  bushel.  Hence,  Irish  linen  producers  will  prefer 
to  buy  wheat  in  Canada ;  and,  with  Canada  demanding 
Irish  linen,  Irish  wheat  producers  will  find  a  more  prof¬ 
itable  occupation  in  making  linen.  As  we  have  seen,1 
it  is  altogether  probable  that  some  goods  will  be  lower 
in  price  in  each  country  than  in  the  other.  All  prices 
could  not  long  be  lower  in  either,  since  the  resulting  in¬ 
flow  of  gold  would  raise  them.  While  there  is  no  special 
virtue  in  the  particular  prices  of  $1  a  bushel  and  $1  a 
yard  here  assumed  for  illustration,  the  conditions  of 
production  in  each  country,  as  stated  in  the  hypothesis, 
are  such  as  would  make  the  wheat  of  Canada  and  the 
linen  of  Ireland  the  cheaper  goods. 

Trade  between  nations,  as  well  as  trade  between  parts 
of  the  same  nation,  results  in  a  gain  to  both  sides,  for  it 
makes  possible  geographical  specialization  and  therefore 
a  more  productive  employment  of  the  factors  of  industry. 


1  §  2  of  this  chapter  (I  of  Part  II). 


16  ECONOMIC  ADVANTAGES  OF  COMMERCE 


In  theoretical  discussion,  international  trade  is  sometimes 
separated  from  intranational  trade,  because  of  the  fact 
that  labor  and  capital  flow,  as  a  rule,  with  greater  diffi¬ 
culty,  from  one  nation  to  another.1  Distance  and  ex¬ 
pense,  a  strange  government,  separation  from  old  friends 
and  old  associations,  unfamiliar  customs,  different  lan¬ 
guage,  different  religion,  —  any  or  all  of  these  considera¬ 
tions  may  prevent  the  free  movement  of  labor  from  one 
country  to  another.  Some  of  them  will  cause  hesitancy 
in  making  foreign  investments.  The  argument  is  that 
within  a  nation,  labor  and  capital  will  move  freely  to 
those  localities  where  they  receive  the  largest  return. 
If  Connecticut  were  more  productive  in  every  way 2 
than  Massachusetts,  then  labor  and  capital  from  Massa¬ 
chusetts  would  flow  freely  into  Connecticut  until  condi¬ 
tions3  were  equalized,  until  the  greater  crowding  of 
Connecticut  and  the  less  crowding  of  Massachusetts 
in  comparison  with  resources,  made  labor  and  capital 
no  more  productive  in  the  former  than  in  the  latter  state. 
If  Massachusetts  had  superiority  in  some  lines  and 
Connecticut  in  others,  they  would  trade ;  while  if  Con¬ 
necticut  were  superior  in  all  lines,  Massachusetts  people 
would  largely  migrate.  But  if  labor  in  the  United 
States  is  more  productive  than  in  England,  even  in  all 
lines,  most  of  the  English  people  may  nevertheless  pre¬ 
fer  to  stay  at  home.  They  will  then  simply  produce 
those  things  in  which  their  disadvantage  is  least.  There 
is  really  no  difference  in  principle  between  international 
and  intranational  trade,  as  such.  In  any  case  there  is 
some  immobility  of  labor  and  capital.  In  any  case 
a  sufficient  inducement  will  at  least  partly  overcome 

1  See  Mill,  Principles  of  Political  Economy,  Book  III,  Ch.  XVII,  §  i. 

2  At  the  margin  of  production.  3  At  the  margin. 


INTERCOMMUNITY  TRADE 


i7 


the  immobility,  —  witness  the  flow  of  Italian,  Greek, 
and  Polish  labor  into  the  United  States.  So  the  differ¬ 
ence  is  one  of  degree  and  not  one  of  kind.  Also,  such 
difference  as  exists  may  be  as  marked  between  widely 
separated  parts  of  the  same  nation  or  empire,  e.g. 
Maine  and  Montana,  or  Ireland  and  Canada,  as  between 
different  nations,  e.g.  Germany  and  Austria.  In  either 
case,  so  long  as  labor  and  capital  remain  where  they  are, 
specialization  is  worth  while. 

§5 

Summary 

In  this  chapter  we  have  discussed  trade  from  the 
standpoint  of  relations  of  prices  and  price  levels,  loca¬ 
tion  of  industries,  and  the  gains  of  trade.  Through 
the  influence  of  trade,  the  price  in  any  country  of  any 
kind  of  goods  tends  towards  equality  with  the  price  in 
other  countries.  The  difference  will  not  much  exceed 
cost  of  carriage  plus  tariffs,  etc.  As  a  consequence, 
the  price  level  of  one  country  is  related,  if  they  have  a 
common  value  standard,  e.g.  gold,  to  the  price  level  of 
other  countries,  but  is  unlikely  to  be  the  same.  The 
prices  of  some  goods  are  lower  in  one  country  and  the 
prices  of  other  goods  are  lower  in  other  countries,  accord¬ 
ing  to  what  each  country  can  produce  with  greatest 
relative  advantage. 

If  a  country  has  great  advantages  for  production  in 
any  line,  it  can  produce  in  that  line  with  great  profit 
and  can  pay  high  wages,  while  yet  selling  abroad  at  low 
prices,  the  goods  so  produced.  It  is  not  necessary  in 
order  that  a  country  shall  export  certain  goods  at  a  low 
price,  that  it  shall  be  able  to  produce  those  goods  with 


PART  11  —  c 


18  ECONOMIC  ADVANTAGES  OF  COMMERCE 


less  effort  than  their  production  would  require  elsewhere ; 
but  only  that  its  disadvantage  shall  be  less  in  that  line 
than  in  others.  On  the  other  hand,  if  one  country  has 
an  advantage  over  another  in  nearly  all  lines,  but  a  greater 
advantage  in  some  lines  than  others,  it  gains  most  by 
specializing  in  those  lines  where  its  advantage  is  greatest. 
Under  conditions  of  free  trade,  there  would  be,  then,  a 
large  amount  of  geographical  specialization,  each  country 
devoting  its  energies  to  those  lines  where  its  productive 
capacity  is  relatively  the  greatest.  Industry  is  turned 
the  more  from  the  lines  it  would  otherwise  follow  in 
each  country,  the  more  widely  and  intensively  restric¬ 
tion  is  followed.  The  gains  from  trade,  when  each  of 
two  communities  has  an  absolute  advantage  over  the 
other,  and  when  each  has  a  relative  advantage  in 
some  line,  were  illustrated  by  hypothetical  figures. 

The  distinction  sometimes  made  between  international 
and  intranational  trade  was  referred  to,  viz.,  that  in 
the  latter  case,  greater  advantages  of  one  community 
in  all  lines  would  cause  movement  of  population,  while 
in  the  former,  immobility  of  labor  and  capital  is  more 
in  evidence.  In  the  former  case  (that  of  international 
trade),  therefore,  differences  in  relative  advantages  may 
sometimes  be  the  principal  basis  of  trade.  But  it  was 
pointed  out  that  this  distinction  is  but  a  distinction  in 
degree,  and  that,  in  any  case,  political  boundaries  are 
often  less  important  factors  in  immobility  of  labor  and 
capital  than  distance  and  natural  barriers. 


CHAPTER  II 


The  Rate  of  Interchange  of  Goods  between  Com¬ 
munities 


The  Limits  to  the  Rate  at  which  the  Goods  of  One  Country 
Exchange  for  Those  of  Another 


We  have  seen  that  differences  in  relative  productive¬ 
ness  bring  about  trade  between  communities  if  there  are 
no  natural  or  artificial  barriers  or  if  these  barriers  are 
not  unduly  great ;  and  that  both  communities  concerned 
gain  by  such  trade.  How  much  each  community  gains 
depends  on  the  rate  at  which  the  goods  of  one  community 
exchange  for  those  of  the  other.  There  are  certain  limits 
between  which  this  rate  fluctuates,  and  at  a  rate  of 
exchange  of  goods  beyond  these  limits,  on  either  side, 
there  would  be  no  trade. 

In  showing  what  these  limits  are,  we  will  again  take 
trade  between  Ireland  and  Canada  for  illustration.  We 
assumed  that  a  week’s  labor  in  Canada  would  produce 
20  bushels  of  wheat  or  14  yards  of  linen.  We  saw,  also, 
that  if  Canadians  could  get  $1  a  bushel  for  wheat,  they 
would  be  willing  to  produce  linen  for  $1.43  a  yard,  but 
not  for  less.  Since  Canadian  wheat  producers  could 
buy  this  cloth  at  home  for  $1.43  a  yard,  they  would  not 
pay  more  than  $1.43  a  yard  for  linen  cloth  brought 
from  Ireland.  At  a  price  greater  than  $1.43  per  yard, 
they  would  cease  to  buy.  If  wheat  is  $1  a  bushel,  then 

19 


20  ECONOMIC  ADVANTAGES  OF  COMMERCE 


a  price  of  $1.43  a  yard  for  linen  means  that  1.43  bushels 
of  wheat  must  be  sold  for  each  yard  of  linen  bought. 
This,  then,  is  one  of  the  limits  beyond  which  trade  will 
not  go.  If  Canadians  have  to  give  up  more  than  1.43 
bushels  of  wheat  to  get  a  yard  of  Irish  linen,  they  will 
lose  by  the  trade ;  if  less,  they  will  gain  by  it,  i.e.  will 
get  more  cloth  by  exchanging  a  week’s  wheat  yield  for 
cloth  than  by  devoting  a  week  to  cloth  production. 
The  same  principle  applies  if  the  level  of  prices  in  Canada 
is  higher  or  lower.  Suppose  Canadian  wheat  could  be 
sold  for  $2  a  bushel.  Then  the  product  of  a  week’s 
labor,  20  bushels,  would  yield  $40.  Obviously,  therefore, 
since  a  week’s  labor  in  linen  production  would  yield, 
in  Canada,  but  14  yards,  a  price  of  $2.85  a  yard  would 
be  required  for  its  production  there.  In  this  case,  it 
would  pay  Canadians  to  devote  themselves  to  wheat 
production  and  sell  their  wheat  at  $2  a  bushel,  so  long 
as  they  could  buy  linen  abroad  at  less  than  $2.85  a  yard. 
At  this  price  or  a  greater,  they  would  no  longer  gain. 
But  we  have  merely  restated  our  limit  in  terms  of  a  new 
price  level.  At  $2.85  a  yard,  Canadians  would  be  parting 
with  1.43  bushels  of  wheat  for  each  yard  of  linen.  What¬ 
ever  the  price  level,  therefore,  so  long  as  20  bushels 
requires,  in  Canada,  the  same  productive  effort  as  14 
yards,  the  limit  beyond  which  Canadians  would  refuse 
to  trade  is  1.43  bushels  per  yard.  At  any  less  price  of 
linen,  Canadians  would  gain,  and  the  lower  the  price, 
the  greater  the  gain  to  Canada.  The  principle  applies, 
also,  if  the  trading  countries  have  entirely  different 
monetary  standards.  If  Canada  had  an  inconvertible 
paper  money,  there  would  still  be  some  price  in  this 
money,  for  Irish  linen,  some  amount  of  this  money  neces¬ 
sary  to  buy  the  foreign  exchange  or  the  gold  to  pay  for 


THE  RATE  OF  INTERCHANGE  OF  GOODS  21 


Irish  linen.  It  would  still  be  true  that  a  yard  of  linen 
produced  in  Canada  would  cost  1.43  times  as  much  as  a 
bushel  of  wheat.  If  the  amount  of  this  money  neces¬ 
sary  to  buy  a  yard  of  linen  in  Ireland  should  be  more  than 
1.43  times  the  cost  of  a  bushel  of  Canadian  wheat,  the 
linen  would  not  be  imported. 

Beyond  one  limit,  Canada  would  gain  nothing  and 
would,  therefore,  refuse  to  trade.  Beyond  the  other 
limit,  Ireland  would  gain  nothing  and  would  refuse  to 
trade.  The  trade,  if  carried  on,  must  benefit  both,  and 
will  therefore  lie  between  these  limits.1  Let  us  see  what 
is  the  limit  beyond  which  Ireland  would  not  trade.  If  a 
week’s  labor  in  Ireland  will  produce  10  yards  of  linen 
or  6  bushels  of  wheat,  and  linen  sells  for  $1  a  yard,  then 
Irish  producers  would  be  willing  to  raise  wheat  for  $1.67 
a  bushel  but  not  for  less.  Since  the  Irish  linen  manu¬ 
facturing  population  can  get  wheat  at  home  by  paying 
$1.67  a  bushel,  to  pay  more  for  Canadian  wheat  would 
involve  a  loss.  If  linen  is  $1  a  yard,  therefore,  Ireland 
will  profit  by  purchasing  Canadian  wheat,  at  any  price 
up  to  $1.67  a  bushel.  Beyond  that  price,  Ireland  will 
refuse  to  buy  from  Canada,  preferring  to  produce  the 
needed  wheat  at  home.  Similarly,  if  linen  made  in 
Ireland  should  sell  for  $0.50  a  yard,  Irish  linen  makers 
could  be  induced  to  produce  wheat  for  about  $0.83  a 
bushel,  and  that  would,  therefore,  be  approximately 
the  limit  to  what  Irish  linen  makers  would  pay  for 
Canadian  wheat.  In  other  words,  whatever  the  level 
of  prices,  the  most  that  Irish  linen  makers  would  pay 
for  a  bushel  of  Canadian  wheat  would  be  1.67  yards  of 

1  Mill,  Principles  of  Political  Economy,  Book  III,  Ch.  XVIII,  §  2.  On  the 
general  theory  of  international  values  the  mathematical  reader  may  be  referred 
to  Edgeworth,  “The  Theory  of  International  Values,”  Economic  Journal,  Vol. 
IV,  1894,  pp.  35-50,  424-443,  606-638. 


22 


ECONOMIC  ADVANTAGES  OF  COMMERCE 


linen.  At  any  less  price  they  would  gladly  buy.  At  a 
more  unfavorable  rate,  they  would  lose,  and  so  would 
refuse  to  trade.  We  have  found,  then,  the  two  limits 
to  exchange.  Between  1.43  bushels  for  1  yard  and  1.67 
yards  for  1  bushel,  the  rate  of  interchange  must  lie  if 
there  is  to  be  any  trade  at  all.  1.67  yards  for  1  bushel 
is  the  same  as  1  yard  for  .60  bushels.  Therefore,  the 
rate  of  trade  must  He  between  1.43  bushels  =  1  yard, 
and  .60  bushel  =  1  yard.  At  either  Emit,  all  the  gain 
from  trade  would  go  to  one  or  the  other  of  the  two  trad¬ 
ing  communities.  Between  these  limits,  the  gain  would 
be  divided  equally  or  unequally  between  those  commu¬ 
nities. 

§  2 

Conditions  of  Supply  and  Demand  Determining  the  Exact 
Rate  of  Interchange  between  these  Limits 

The  question  which  has  now  to  be  answered  is,  what 
determines  the  exact  rate  of  interchange  —  and,  there¬ 
fore,  the  gain  to  each  country  —  between  these  Emits. 
We  shall  find  the  determining  factor  to  be  relative  in¬ 
tensity  of  demand,  or,  to  use  more  familiar  terms,  we 
shall  find  the  rate  to  be  determined  by  supply  and  demand. 
Returning  to  our  illustration,  let  us  suppose  that  at  a 
price  of  $1  a  bushel  for  wheat  and  $1  a  yard  for  linen, 
Ireland  wants  more  bushels  of  wheat  from  Canada 
than  Canada  desires  yards  of  Enen  from  Ireland.  In 
other  words,  Ireland’s  intensity  of  demand  for  wheat  at 
these  prices  of  wheat  and  Enen,  is  greater  than  Canada’s 
intensity  of  demand  for  Enen.  An  excess  of  money  would 
then  flow  into  Canada  and  prices  in  Canada  would  rise, 
while  in  Ireland  they  would  fall.1  This  would  continue 

1  Throughout  this  book  it  should  be  borne  in  mind  that  the  rise  and  fall  may 
be  only  relative.  There  may  be  a  general  rise  of  prices,  in  which  case  Canadian 


THE  RATE  OF  INTERCHANGE  OF  GOODS  23 


until  a  scale  of  prices  was  reached  at  which  trade  would 
be  in  equilibrium,  i.e.  at  which  Canada  would  buy  as 
many  dollars’  worth  of  linen  as  Ireland  would  buy  of 
wheat.1  Let  us  suppose  that  this  stage  is  reached  when 
the  quantity  of  money  in  Canada  is  yj-  of  its  former 
amount,  and  in  Ireland  (having  smaller  population, 
wealth,  and  currency,  and  being,  therefore,  affected 
through  an  inflow  or  outflow,  by  a  greater  per  cent), 
J  of  its  former  amount.2  Then,  by  the  quantity  theory 
of  money,  prices  in  Canada  would  be  some  10  per  cent 
higher  than  previously.  Assuming  Canadian  prices 
all  to  rise  in  this  proportion,3  Canadian  wheat  would  sell 
for  $1.10  a  bushel.4  Canadians  would  now  be  unwill¬ 
ing  to  make  linen  for  less  than  ff  of  this,  or  $1.57 
a  yard.  On  the  other  hand,  Irish  linen  would  sell  for 

prices  rise  in  greater  degree  than  those  of  Ireland.  Or  there  may  be  a  general 
fall  of  prices,  in  which  case  Irish  prices  fall  in  greater  degree  than  those  of  Canada. 
The  important  facts  for  our  argument  are  the  relation  of  Canadian  to  Irish  prices 
and  the  changes  in  this  relation.  The  discriminating  reader  will  easily  see  that 
none  of  our  essential  conclusions  are  affected  by  the  qualification  here  set  forth. 

1  See  Taussig,  Principles  of  Economics,  Vol.  I,  New  York  (Macmillan),  1911, 
pp.  496,  497.  We  are  here  assuming  only  two  kinds  of  goods,  linen  and  wheat, 
to  enter  into  the  trade. 

2  If  the  difference  in  intensity  of  demand  is  slight  at  prices  of  $1  per  bushel 
and  $1  per  yard,  it  is  conceivable  that  equilibrium  may  be  reached  by  slight 
changes  in  the  rates  of  exchange,  insufficient  to  cause  a  flow  of  gold.  A  rate  of 
exchange  in  Ireland,  on  Canada,  slightly  above  par,  and  a  rate  in  Canada,  on 
Ireland,  slightly  below  par,  will  slightly  discourage  Irish  buying  from  Canada 
(or  Canadian  selling  to  Ireland)  and  slightly  encourage  Canadian  buying  from 
Ireland  (or  Irish  selling  to  Canada). 

3  Since  the  goods  imported  from  Ireland  would  not  rise  in  price,  but  would 
fall,  and  since  these  goods  must  be  handled,  in  Canada,  by  middlemen,  other 
prices  must  rise  by  more  than  fa  to  make  an  average  rise  of  that  proportion. 
But  if  exchanging  in  Canada  the  goods  brought  from  Ireland,  forms  but  a  small 
proportion  of  Canada’s  total  internal  trade  (and  it  is  not  unreasonable  to  sup¬ 
pose  this),  then  a  rise  in  all  other  prices  of  not  much  more  than  would  make 
an  average  rise  of  fully  that. 

4  The  circumstances  which  might  prevent  wheat  from  changing  to  the  same 
extent  as  many  other  prices,  are  discussed  in  later  chapters.  For  the  present, 
these  circumstances  are  assumed  to  be  non-existent. 


24  ECONOMIC  ADVANTAGES  OF  COMMERCE 


J  of  its  former  price,  or  about  $0.88.  Irish  workers 
could  now  be  induced  to  produce  wheat  for  -V0-  of  this, 
or  about  $1.46.  This  is  cheaper  than  before  ($1.67), 
but  Ireland  would  still  gain  by  consuming  Canadian 
wheat,  while  Canada  would  gain  more  than  before  by 
purchasing  Irish  linen.  Canada  gets  more  for  her  wheat 
than  before  and  pays  less  for  her  cloth,  because  Ireland’s 
demand  is  the  more  intense.  One  bushel  of  wheat  now 
gets  $^,  and  buys  a  yard  of  linen.  One  bushel 
of  wheat,  therefore,  now  buys  1.26  yards.  Ireland  gains 
less  than  before,  but  the  trade  is  still  inside  the  limit  of 
profitableness  to  Ireland.  Ireland  gives  1.26  yards  for 
one  bushel,  while  the  limit  of  profitableness  is  1.67  yards 
for  one  bushel.  At  the  new  rate  of  interchange,  Canada 
may  be  induced  to  buy  more  linen  and  Ireland 
prevented  from  buying  so  much  wheat.  Where  an 
equilibrium  is  found,  there  will  be  the  rate  of  trade.1 

Except  as  to  relations  of  money  prices,  the  conclu¬ 
sion  is  the  same  if  the  two  countries  engaged  in  trade 
have  different  monetary  standards.  If  Canada,  for 
example,  had  paper  money  not  redeemable  in  gold, 
an  excess  demand  from  Ireland  for  Canadian  wheat 
could  not,  it  is  true,  increase  Canadian  money  or  Cana¬ 
dian  prices ;  but  it  would,  as  we  saw  in  an  earlier  chap¬ 
ter,2  change  the  relative  values  of  Irish  and  Canadian 
money,  so  that  buyers  in  Ireland  of  Canadian  wheat 
must  spend  more  of  their  money  for  each  bushel  pur- 


1  Mill  suggests  that  there  may  be  several  rates  satisfying  the  conditions  of 
equilibrium,  Principles  of  Political  Economy,  Book  III,  Ch.  XVIII,  §  6.  This 
might  conceivably  be  the  case  if  the  trade  were  between  two  nations,  each  free 
of  competition  from  others,  and  if  few  articles  entered  into  the  trade.  In  the 
complications  of  actual  commercial  relations,  it  is  practically  impossible  that  it 
should  be  so. 

2  See  Part  I,  Ch.  VI,  §§  7,  8. 


THE  RATE  OF  INTERCHANGE  OF  GOODS  25 


chased,  and  so  that  Canadians  could  buy  each  yard  of 
linen  at  a  cost,  in  Canadian  money,  less  than  before. 
At  some  rate  of  interchange  of  wheat  and  linen,  the  trade 
would  balance. 

The  rate  would  be  determinable,  also,  if  no  money 
were  used  and  trade  were  all  in  the  form  of  direct  barter. 
The  country  having  the  more  intense  demand  would, 
as  under  existing  forms  of  trade,  offer  a  better  rate.1 
We  may,  if  we  so  desire,  say  that  at  present  a  trade 
between  communities  is  resolvable  into  two  trades,  one 
of  goods  for  money,  and  a  second  of  money  for  other 
goods.  If  we  so  look  at  the  situation,  we  may  further 
say  that  each  of  the  two  trades,  separately,  illustrates 
the  effect  of  relative  intensity  of  demand.  The  country 
which  is  the  more  anxious  to  get  the  goods  of  the  other 
will  show  a  relatively  great  intensity  of  demand  for 
money  or  gold,  giving  a  comparatively  large  amount 
of  its  own  products  for  a  given  sum  of  money;  and  it 
will  then  show  its  intensity  of  demand  for  the  desired 
products  of  the  other  country  by  giving  large  amounts 
of  money  or  gold  for  these. 

In  more  familiar  phraseology,  we  may  say  that  the 
rate  at  which  linen  exchanges  for  wheat  is  fixed  by  supply 
and  demand,  and  will  be  such  a  rate  that  the  supply  of 
wheat  offered  to  Ireland  by  Canada  is  equal  to  Ireland’s 
demand  for  wheat;  otherwise  stated,  that  the  supply 
of  linen  offered  to  Canada  by  Ireland  shall  be  equal  to 
the  amount  demanded. 

1  The  general  principle,  in  fact,  even  when  actual  modern  trade  has  been  in 
view,  has  been  frequently  explained  by  economists  without  special  reference 
to  the  flow  of  money.  See,  for  example,  Mill,  Principles  of  Political  Economy, 
Book  III,  Ch.  XVIII,  §  2 ;  see  also  Bastable,  The  Theory  of  International  Trade, 
fourth  edition,  London  (Macmillan),  1903,  p.  27.  The  flow  of  money  has  then, 
as  in  Mill,  Ch.  XIX  of  Book  III,  and  Bastable,  Ch.  Ill,  been  brought  under  the 
general  law. 


26  ECONOMIC  ADVANTAGES  OF  COMMERCE 


§  3 

Effect  on  this  Rate ,  when  One  of  the  Countries  Offers  a 
Variety  of  Goods  in  Trade ,  and  also  when  it  Receives 
Periodic  Payments  of  Obligations  from  the  Other 

We  must  now  modify  our  hypotheses,  to  make  them 
conform  more  nearly  to  actual  conditions.  In  trade 
between  two  countries,  there  are  almost  certain  to  be 
more  than  two  commodities  or  services  involved.  Ire¬ 
land,  to  recur  to  our  illustration,  will  probably  buy  other 
things  than  wheat  of  Canada,  possibly  furs,  timber, 
iron  ore,  etc. ;  while  Canada  is  likely  to  buy  other 
things  than  linen  of  Ireland.  Then,  even  if,  at  $i  per 
bushel  and  $i  per  yard,  respectively,  Ireland  wants  more 
wheat  than  Canada  does  linen,  money  does  not  neces¬ 
sarily  flow  to  Canada,  changing  relative  prices  and  the 
gains  of  trade.  For  Canada’s  desire  to  purchase  other 
Irish  goods  may  be  intense  enough  to  keep  the  relative 
distribution  of  money  and  the  relative  benefits  of  trade 
as  they  were. 

In  general,  we  may  say  that  the  more  varieties  of 
goods  a  country  can  offer  for  export,  the  better  is  its 
position  in  trade.1  England’s  position,  for  example, 
is  better  if  it  produces  several  kinds  of  goods  for  foreign 
sale  than  if  it  produces  but  one.  The  demand  of  France 
or  Italy  or  other  countries  for  these  several  kinds  of 
goods  will  be  greater  than  for  any  one  thing  alone.  As 
a  consequence,  there  will  be  a  greater  tendency  for  gold 
to  flow  into  England,  making  English  prices  higher  and 
French,  or  other  prices,  lower,  so  giving  England  a 
larger  gain  from  the  trade.  The  more  largely  English 
merchants  and  manufacturers  can  introduce  English 

1  Mill,  Principles  of  Political  Economy,  Book  III,  Ch.  XVIII,  §  6. 


THE  RATE  OF  INTERCHANGE  OF  GOODS  27 


goods  into  favor  in  the  Orient,  in  Africa,  in  South  America, 
or  elsewhere,  the  greater  is  the  gain,  not  to  these  mer¬ 
chants  and  manufacturers  alone,  but  to  the  English 
nation.  Among  the  goods  that  England  is  in  a  position 
to  offer,  must,  of  course,  be  included  banking  service, 
freight  service,  etc.,  as  well  as  commodities.  The  fact 
that  other  countries  desire  to  make  use  of  her  ships  is 
as  much  a  help  toward  making  trade  more  profitable 
to  England  as  the  fact  that  other  nations  desire  to  buy 
her  manufactures. 

In  a  similar  way,  England  is  helped  by  the  fact  that 
her  people  have  large  investments  abroad,  on  which 
they  receive  interest,  dividends,  etc.1  According  to 
the  principles  set  forth  in  Part  I,  Chapter  V,2  this  means 
flow  of  gold  to  England,  higher  prices  there,  lower  prices 
where  the  money  comes  from,  and,  consequently,  a 
flow  of  money  back  again  from  England.  In  the  long 
run,  England  receives  interest  in  the  form  of  goods 
rather  than  of  money.  The  money  tends  to  flow  back 
until  the  normal  equilibrium  is  restored.  But  if  Eng¬ 
land  has  relatively  permanent  investments,  say  in 
the  United  States,  and  is  therefore  receiving  interest 
and  dividend  payments  from  the  United  States  for 
many  years  in  succession,  the  normal  equilibrium  of 
prices  probably  will  not,  during  all  that  time,  be 
reached.  As  fast  as  this  equilibrium  is  approached, 
further  interest  and  dividend  payments  upset  it. 
For  a  great  many  years,  therefore,  English  prices 
are  likely  to  be  somewhat  higher,  and  American 
prices  somewhat  lower,  than  would  be  the  case  if 
Americans  owed  nothing.  During  this  period,  then, 
England  will  get  somewhat  more  for  English  goods 

1  Taussig,  Principles  of  Political  Economy,  Vol.  I,  p.  499.  2  §  8. 


28  ECONOMIC  ADVANTAGES  OF  COMMERCE 


and  pay  somewhat  less  for  American  goods,  than 
otherwise.  The  rate  of  interchange  is  slightly  more 
favorable  to  England  than  it  would  otherwise  be. 
Even  assuming  all  trade  to  be  carried  on  in  the 
form  of  barter,  this  conclusion  would  still  hold  true. 
For  if  England  were  getting  continuous  interest  in 
American  goods,  English  desire  for  such  goods  would 
be  partly  satisfied,  their  utility  to  the  people  of  Eng¬ 
land  would  be  less  (law  of  diminishing  utility),  and 
they  would  have  to  be  offered  at  a  less  value  in  terms 
of  English  goods.1 

On  the  other  hand,  England’s  advantage  in  the  rate 
of  trade,  due  to  payments  of  interest,  etc.,  which  have 
to  be  made  to  Englishmen,  must  be  regarded  as  an  offset 
to  a  corresponding  disadvantage  in  the  rate  of  trade, 
during  the  period  when  the  investments  (on  which  in¬ 
terest,  dividends,  etc.,  are  being  received)  were  made. 
During  the  period  when  England’s  (or  any  country’s) 
annual  investment  abroad  exceeded  her  annual  profits 
from  abroad,  the  tendency  was  for  gold  to  flow  from 
England  to  other  places.  This  tended  to  make  prices 
elsewhere  higher,  and  English  prices  lower,  to  give  other 
countries,  for  the  time  being,  a  more  favorable  rate  of 
interchange  of  goods  with  England.  A  country  whose 
people  are  making  large  investments  abroad,  then,  will 
have  to  dispose  of  its  goods,  for  the  time  being,  at  a  less 
favorable  rate;  but  it  will  later,  during  realization  of 

1  The  law  of  diminishing  utility  is  the  fundamental  explanation  of  England’s 
gain  in  our  illustration,  even  if  money  is  used.  Were  it  not  for  the  law  of  dimin¬ 
ishing  utility,  no  change,  or  no  appreciable  change,  in  relative  price  levels  would 
be  required  to  bring  about  the  flow  back,  for  goods,  of  the  money  paid  in  divi¬ 
dends,  etc.  The  flow  back  would  begin  to  take  place  before  the  flow  of  money 
into  England  had  appreciably  changed  the  price  level  there  or  here,  and  would 
take  place,  therefore,  without  making  the  rate  of  interchange  of  goods  appre¬ 
ciably  more  favorable  to  England. 


THE  RATE  OF  INTERCHANGE  OF  GOODS  29 


profits  and  repayment,  be  able  to  dispose  of  its  goods  at 


a  more  favorable  rate.1 

§4 


Influence  on  Trade  and  the  Rate  of  Trade  of  Production 
in  any  Country  under  Conditions  of  Different  Cost 

Up  to  this  point,  we  have  assumed  the  commodities 
entering  into  trade  to  be  produced  at  constant  cost  per 
unit,  regardless  of  the  amounts  produced.  But  such  is 
by  no  means  always  the  case.  Let  us  revert  to  the  in¬ 
stance  of  Ireland  trading  with  Canada.  One  week’s 
labor  in  Ireland  was  supposed  to  produce  6  bushels  of 
wheat.  As  a  matter  of  fact,  all  land  is  not  alike  in  fer¬ 
tility  or  in  convenient  access  to  market.  While,  there¬ 
fore,  it  might  be  true  that,  if  Ireland  produced  all  her 
own  wheat,  one  week’s  labor  at  the  margin  of  cultiva¬ 
tion  (that  is,  on  those  lands  least  favorable  to  wheat 
production  of  all  the  lands  so  used,  but  which  must  be 
devoted  to  wheat  production,  to  secure  an  adequate 
supply)  might  produce  but  6  bushels;  a  week’s  labor 
in  other  parts  of  Ireland  would  perhaps  produce  a  great 
deal  more.  If  Ireland  produced  all  her  own  wheat,  the 
people  of  Ireland  would  have  to  produce  it,  perhaps,  on 
unfertile  lands  and  where  the  conditions  of  production 
were  relatively  unfavorable.  It  might,  therefore,  be 
uneconomical  for  Ireland  to  produce  her  own  entire 

1  Since  investment  is  really,  in  large  part,  a  purchase  of  capital  goods,  e.g. 
railways,  farms,  factories,  etc.,  it  may  be  asked  why  the  general  discussion  re¬ 
garding  the  trade  of  the  goods  of  one  country  for  the  goods  of  another  does  not 
cover  investment  also.  But  investment  is  rather  the  purchase  of  rights  in  goods 
which  are  not  themselves  moved.  The  capital  purchased  remains  in  the  foreign 
country  and  yields  future  income  to  the  distant  investors.  This  yielding  of 
future  income,  involves  a  later  and  opposite  influence  on  the  rate  of  trade  be¬ 
tween  the  countries,  which  does  not  occur  when  the  owners  and  the  capital  owned 
are  in  the  same  place.  Hence,  special  consideration  must  be  devoted  to  the 
effects  of  lending  and  investing,  on  trade. 


30  ECONOMIC  ADVANTAGES  OF  COMMERCE 


supply  of  wheat.  Some  wheat  should  rather  be  imported 
from  Canada.  But  it  might  well  be  profitable  for  the 
people  of  Ireland  to  employ  some  of  their  more  fertile 
land,  if  not  better  situated  and  adapted  for  other  crops, 
in  wheat  production.1  The  possession  of  this  more 
fertile  land  would  lessen  the  intensity  of  Ireland’s  demand 
for  Canadian  wheat,  and  would  thus  tend  to  make  the 
rate  of  trade  between  the  countries  more  favorable 
to  Ireland  than  if  her  entire  supply  of  wheat  had  to  be 
secured  from  abroad.  If  linen  sells  for  $i  a  yard  and 
Canadian  wheat  is  $i  a  bushel,  then  it  is  of  course  more 
profitable  for  Ireland  to  buy  Canadian  wheat  than  to 
produce  wheat  on  poor  Irish  land,  under  intensive  culti¬ 
vation  ( i.e .  with  but  small  areas  of  land  for  each  unit  of 
labor),  where  a  week’s  labor  can  only  produce  6  bushels, 
and  where  it  can  only  be  remunerated  by  a  price  of  $1.67 
a  bushel.  But  it  would  be  profitable  for  Ireland  to  pro¬ 
duce  wheat  for  home  consumption  on  land  where  a 
week’s  labor  would  yield  14  or  13  or  down  to  10  bushels, 
unless  this  land,  or  part  of  it,  was  so  situated  and  adapted 
as  to  yield  still  more  from  some  other  use,  e.g.  from  being 
used  to  raise  potatoes.  A  yield  of  10  bushels  a  week 
would  require  only  $1  a  bushel  (linen  being  $1  a  yard), 
to  induce  wheat  production  in  Ireland,  and  so  to  raise 
the  wheat,  would,  by  our  hypothesis,  be  as  economical 
as  to  import  it  from  Canada.  On  land  yielding  7,  8,  9, 
or  less  than  10  bushels  a  week,  wheat  production  in  Ire¬ 
land  is  uneconomical  as  long  as  a  yard  of  linen  cloth  will 
buy  from  Canada  a  bushel  of  wheat.  So  it  results  that, 
because  of  the  law  of  diminishing  returns,  it  is  often  most 
profitable  for  a  country  to  produce,  in  part,  its  desired 
supply  of  some  commodity,  and  import  the  rest.  If  the 

1  Bastable,  Theory  of  International  Trade,  pp.  29  and  30, 


THE  RATE  OF  INTERCHANGE  OF  GOODS  31 


demand  for  wheat  in  Ireland  became  greater,  poorer 
Irish  sources  of  production  would  perhaps  be  resorted 
to  for  a  small  part  of  the  supply,  while  somewhat  more 
would  be  imported  from  Canada  and  elsewhere  at  the 
higher  price,  relative  to  linen  cloth,  resulting  from  this 
greater  demand. 

By  similar  reasoning  it  may  be  shown  that  beyond  a 
certain  point  of  high  cost,  wheat  production  in  Canada 
for  export  would  not  be  carried,  but  that  the  people  of 
Canada  would  prefer  to  devote  themselves,  in  part,  to 
other  work,  even  to  the  manufacture  of  linen.  Cana¬ 
dians  would  not  carry  wheat  production  to  land  so  poor 
(assuming  a  great  increase  in  population)  as  to  yield 
less  than  14  bushels  a  week,  so  long  as  14  yards  of  linen 
could  be  produced  in  a  week’s  labor;  for,  beyond  that 
point,  it  would  pay  better  to  produce  linen  at  $1  a  yard 
than  wheat  at  $1  a  bushel.  Growing  density  of  popu¬ 
lation  tends,  in  general,  to  the  spread  of  manufacturing, 
because  employment  in  agriculture,  after  a  certain  degree 
of  intensiveness  of  cultivation  has  been  reached,  becomes 
less  profitable  at  the  margin  the  more  persons  are 
engaged  in  it. 

It  has  been  the  good  fortune  of  the  American  people 
that  they  have  lived  in  a  country  not  overpopulated 
and  one  of  very  considerable  natural  resources.  They 
have  had  always,  therefore,  the  opportunity  to  engage 
in  the  extractive  industries,  particularly  in  agriculture, 
and  realize  large  returns  in  so  doing.  They  have  not 
had  to  take  up  manufacturing,  however  small  the  profits, 
merely  for  the  lack  of  a  profitable  alternative,  though 
they  have  found  it  worth  while  to  engage  in  various 
lines  of  manufacturing  industry  which  American  re¬ 
sources  or  American  methods  make  especially  productive 


32  ECONOMIC  ADVANTAGES  OF  COMMERCE 

in  the  United  States.  If  other  countries,  such  as  Eng¬ 
land  and  Germany,  are  forced  by  dense  populations 
and  limited  resources  to  engage  in  manufacturing  to  a 
greater  relative  degree,  Americans  have,  on  that  account, 
no  reason  for  envy,  nor  any  reason  for  attempting, 
through  tariffs  or  other  arbitrary  interferences,  to  force 
American  industry  more  largely  into  parallel  channels. 

§5 

Extension  of  Hypothesis  so  as  to  Include  Trade  Involving 

More  than  Two  Countries 

As  we  broadened  our  first  hypothetical  conditions 
so  as  to  include  more  than  two  kinds  of  goods,  we  shall 
now  further  broaden  them  so  as  to  consider  more  than 
two  trading  communities.  We  have  assumed  Ireland 
and  Canada  to  be  engaged  in  trade  with  each  other. 
But  trade  may  be  three-cornered  or  four-cornered  or 
more.  Ireland  may  sell  its  linen  chiefly  to  the  United 
States  instead  of  to  Canada ;  the  United  States  may  sell 
cotton  to  Canada ;  and  Canada  may  in  turn  export  wheat 
to  Ireland.  Under  these  circumstances,  the  rates  of 
interchange  would  still  depend  on  relative  intensities 
of  demand.  The  rate  at  which  Ireland  can  exchange 
linen  for  wheat,  depends  on  the  price  which  can  be  re¬ 
alized,  in  the  United  States,  for  linen,  and  the  price  which 
must  be  paid,  in  Canada,  for  wheat,  or  upon  the  intensity 
of  American  demand  for  the  linen  compared  to  the  in¬ 
tensity  of  Irish  demand  for  the  wheat.  The  American 
demand  for  the  linen,  at  any  price,  will  depend,  in  part, 
on  what  Americans  can  get  for  cotton.  The  Canadian 
demand  for  cotton  will  depend,  in  part,  on  what  Cana¬ 
dians  can  get  for  wheat.  If  Ireland  has  a  surplus  de- 


THE  RATE  OF  INTERCHANGE  OF  GOODS  33 


mand  for  wheat  at  $1  a  bushel,  gold  will  flow  to  Canada 
and  Canadian  prices  will  rise.  Canadians  may  then 
buy  more  cotton,  in  which  case  American  prices  will 
rise.  Irish  prices  will  fall,  and  Americans  will  probably 
buy  more  linen.  When  equilibrium  is  reached,  Ireland 
will  be  paying  somewhat  more  for  wheat  and  getting 
somewhat  less  for  linen.  The  United  States  will  prob¬ 
ably  be  getting  somewhat  more  for  cotton  and  will  be 
paying  somewhat  less  for  linen.  Canada  or  the  United 
States  or  both  will  gain  more  from  the  trade,  and  Ire¬ 
land  will  gain  less.  As  in  trade  between  two  countries, 
equilibrium  will  be  reached  at  a  set  of  relative  prices 
or  values  which  equalizes  supply  and  demand. 

How  are  the  commercial  interests  of  three  nations 
affected  by  the  entrance  of  the  third  into  trade  with 
the  other  two?  The  general  effect  will  be  an  increase 
of  prosperity,  and  it  is  entirely  possible  that  each  of  the 
three  countries  will  gain  something.  Suppose,  to  take 
a  seemingly  most  unfavorable  case,  that  France  enters  a 
trade  previously  confined  to  Ireland  and  Canada,  as  a 
competitor  of  Ireland,  competing  with  the  last-named 
country  in  the  sale  of  linen  to  Canada  and  in  the  purchase 
of  wheat  from  Canada.  In  so  far  as  France  engages 
in  this  trade  and  no  other,  Ireland  is  deprived  of  a  part 
of  her  former  gain ;  but  there  is  no  net  loss,  for  France 
and  Canada  together  gain  as  much  as  Ireland  loses,  or 
more.  In  consequence  of  the  competition  of  France, 
linen  will  fall  in  price,  or  wheat  will  rise,  or  both,  so  that 
a  yard  of  linen  buys  less  wheat  than  before.  So  far  as 
Ireland  still  engages  in  the  trade,  at  the  new  and,  to  her, 
more  unfavorable  rate  of  interchange,  Canada  gains, 
besides  her  former  profit,  precisely  what  Ireland  has 
ceased  to  gain.  So  far  as  Ireland  is  driven  out  of  the 


PART  II  —  D 


34  ECONOMIC  ADVANTAGES  OF  COMMERCE 


trade  by  the  entrance  of  France,  France  gains  at  least 
as  much  trade  as  Ireland  loses,  though  at  a  rate  of  in¬ 
terchange  somewhat  more  profitable  to  Canada  and 
somewhat  less  so  to  France,  than  would  be  necessary 
were  Ireland’s  competition  absent.  So  far  as  France  loses 
through  the  less  favorable  rate  of  interchange  caused 
by  Ireland’s  competition,  Canada  gains.  If  the  result 
of  the  competition  is  a  larger  trade  for  Canada  with  the 
other  two  countries  than  Canada  previously  had  with 
the  one,  as  well  as  a  more  favorable  rate,  then  Canada 
gains  more  than  either  of  the  others  loses  or  than  both 
lose;  for  Canada’s  greater  gain  on  the  same  trade  as 
before,  at  the  better  rate,  makes  up  for  the  lessened  gain 
of  the  other  or  others ;  while  the  additional  trade,  which 
must  be  at  least  worth  having  to  the  other  country  or 
countries,  else  it  or  they  would  not  trade,  is  a  very  consid¬ 
erable  gain  to  Canada.  The  competing  countries,  there¬ 
fore,  though  they  may  hurt  each  other,  will  benefit  by 
at  least  as  much,  and  probably  by  more,  the  country  or 
countries  for  whose  trade  they  compete. 

If,  now,  besides  competing  against  Ireland  in  the  trade 
with  Canada,  France  also  enters  into  trade  with  Ireland, 
both  Ireland  and  France  may  gain  from  this  trade  as 
much  as,  or  more  than,  they  are  losing  by  their  competi¬ 
tion.  Then  the  entering  of  France  into  trade  relations 
with  the  other  two  countries  will  benefit  Canada,  Ire¬ 
land,  and  France.  It  seems  a  perfectly  fair  statement, 
therefore,  that  the  more  widely  trade  is  voluntarily, 
and  without  governmental  encouragement,  extended,  i.e. 
the  more  countries  enter  into  it,  the  greater  is  the  total 
gain;  and  that  there  is  reasonable  hope  for  a  greater 
net  gain  to  all  countries  concerned.  In  no  case  can 
the  entrance  of  an  additional  country  or  community 


THE  RATE  OF  INTERCHANGE  OF  GOODS  35 


cause  a  country  or  community  already  engaged  in  a  trade, 
to  engage  thereafter  in  a  losing  trade.  It  has  already 
been  explained  that  unless  a  trade  yields  a  gain  to  both 
(as,  of  course,  to  all,  if  more  than  two)  countries  con¬ 
cerned,  the  trade  will  not  take  place.  The  most  that 
the  new  competition  can  do  is  to  decrease  this  gain  for 
the  country  or  countries  on  one  side  of  the  trade.  And, 
as  above  pointed  out,  the  countries  which  lower  each 
other’s  gains  by  competition  for  the  trade  of  a  third 
country,  may  increase  each  other’s  gains  by  trade  with 
each  other. 

Any  country  gains  more,  the  more  numerous  the  other 
countries  which  desire  its  products  and  the  more  nu¬ 
merous  the  other  countries  which  have  goods  to  offer  it. 
On  the  other  hand,  the  competitive  entering  of  many 
countries  into  trade  makes  it  impossible  for  any  one 
country  to  gain  so  extreme  a  share  of  the  advantage  in 
trade  with  another  as  otherwise  it  might.  The  one 
country  will  seldom  have  a  monopoly  of  the  production 
of  goods  needed  in  the  other  and  will  seldom  be  the  only 
place  where  the  other  can  sell  its  products.  Alternative 
markets  will  generally  be  available,  and  the  gains  of 
trade  are  therefore  likely  to  be  more  nearly  equal  between 
two  trading  countries.  It  is  for  these  reasons  that  the 
policy  of  European  nations,  in  early  colonial  days,  of 
restricting  the  trade  of  colonies  with  other  than  their 
respective  mother  countries,  might  be  advantageous 
to  the  mother  countries,  but  was  at  the  same  time  dis¬ 
advantageous  to  the  colonies. 


36  ECONOMIC  ADVANTAGES  OF  COMMERCE 


Cost  of  Transportation  as  Related  to  Trade 


Cost  of  transportation  is  a  factor  influencing  trade, 
which  must  be  considered  before  our  discussion  is  com¬ 
plete.  This  cost  subtracts  from  the  gains  of  trade  the 
amount  necessary  to  remunerate  those  engaged  in  carry¬ 
ing  the  goods.  The  principles  determining  how  much 
gain  is  realized  by  each  country  are,  of  course,  unaffected. 
Trade  which  cannot  yield  enough  to  pay  for  transporta¬ 
tion  simply  does  not  take  place,  unless  it  is  artificially 
stimulated,  as  by  government  bounties. 


Summary 


In  this  chapter  we  have  confined  our  attention  almost 
entirely  to  the  rate  of  interchange  of  goods  between 
trading  communities  and  countries.  We  have  seen  that, 
in  the  case  of  trade  between  any  two  countries,  the  rate 
at  which  the  goods  of  the  one  exchange  for  the  goods  of 
the  other  cannot  lie  beyond  either  of  two  limits,  at  the 
one  of  which  the  one  country,  and  at  the  other  of  which 
the  other  country,  gains  nothing  from  the  trade.  Be¬ 
tween  these  limits,  the  exact  rate  is  fixed  by  the  com¬ 
parative  intensity  of  demand  of  each  country  for  the 
goods  of  the  other,  or,  to  use  familiar  terms,  by  supply 
and  demand.  Whether  gold  is  a  common  standard  of 
value,  or  the  currencies  unrelated,  or  the  trade  direct 
barter  of  goods  for  goods,  the  rate  of  interchange  will 
be  fixed  where  intensities  of  demand  balance. 

A  country  is  the  more  likely  to  get  a  large  share  of 
the  total  gain  resulting  from  its  trade  with  another 


THE  RATE  OF  INTERCHANGE  OF  GOODS  37 


country  or  countries,  the  greater  the  variety  of  goods 
it  can  offer  to  stimulate  the  desire  of  the  other  country 
or  countries  to  trade.  In  like  manner,  a  country  to 
which  payments  have  to  be  made  by  other  countries, 
e.g.  of  interest  and  dividends,  is  in  a  position  to  get,  in 
consequence,  more  favorable  rates  of  interchange,  though 
such  a  country  may  have  had,  previously,  during  the 
period  of  its  investing  operations,  somewhat  less  favor¬ 
able  rates. 

The  assumption  first  made  that  each  country  would 
buy  of  the  other  the  goods  securable  most  cheaply  from 
the  other,  was  explained  and  qualified  to  conform  with 
the  fact  of  differing  cost  of  production  of  any  good,  within 
the  same  country.  It  was  pointed  out  that  a  country 
might  produce  for  itself  a  certain  amount  of  a  desired 
kind  of  goods,  from  its  most  favorable  sources  of  supply, 
or  up  to  the  point  where  further  home  production  would 
involve  uneconomical  employment  of  its  labor  and  capi¬ 
tal  ;  and  that  beyond  that  point  it  would  import. 

Our  assumptions  were  further  broadened  to  include 
trade  involving  more  than  two  countries.  Three-cor¬ 
nered  trade  was  alluded  to,  and  it  was  shown  that  the 
influence  of  comparative  intensity  of  demand  is  of  deter¬ 
mining  force  in  this  case  and  likewise  in  cases  involving 
still  more  countries.  If  a  third  country  (or  a  fourth 
or  fifth)  enters  into  a  trade  previously  confined  to  two 
countries  (or  three  or  four),  the  result  will  be  a  greater 
total  prosperity,  although  if  the  third  country  enters 
the  trade  only  as  a  competitor  of  one  of  the  others,  that 
one  may  find  its  gains  somewhat  reduced.  If  each  trades 
with  each  of  the  others,  there  is  a  reasonable  prospect 
for  increased  prosperity  to  all  three.  Any  country, 
however,  is  prevented  by  the  entrance  of  other  countries 


38  ECONOMIC  ADVANTAGES  OF  COMMERCE 

into  competition  with  it  from  realizing  exorbitant 
profits  at  the  expense  of  the  countries  it  trades  with. 
On  the  other  hand,  any  country  gains  the  more  from 
trade,  the  larger  the  number  of  other  countries  which 
compete  with  each  other  in  buying  from  and  selling  to  it. 


CHAPTER  III 


The  Incidence  of  Tariffs  for  Revenue 


Revenue  and  Protective  Tariffs  Distinguished 

So  far  we  have  discussed  international  trade  mainly 
on  the  assumption  that  such  trade  is  wholly  free.  As  a 
matter  of  fact,  trade  is  almost  never  wholly  free  between 
nations,  though  it  is  frequently  so  within  the  boundaries 
of  a  single  nation.  One  of  the  largest,  if  not  the  largest, 
of  free  trade  areas  in  the  world,  is  the  United  States. 
Between  one  state  and  another,  any  tariff  is  unconsti¬ 
tutional.  We  have,  therefore,  free  trade  within  our 
own  borders,  though  not  with  outside  nations.  Almost, 
if  not  quite,  every  nation  has  a  tariff  wall,  high  or  low 
as  the  case  may  be,  which,  usually,  to  a  greater  or  less 
extent,  hampers  trade.  Tariff  duties  at  the  boundaries 
of  a  country  may  be  levied  on  goods  imported  or  on  goods 
exported,  but  in  practice  are  much  more  likely  to  be 
levied  on  the  former.  We  shall  consider  the  economic 
effects  of  both  import  and  export  duties. 

Import  duties  are  of  two  sorts,  revenue  tariffs  and 
protective  tariffs.  A  strict  revenue  tariff  is  intended 
to  raise  revenue,  while  not  interfering  with  trade  more 
than  is  necessary.  Although  absolute  free  trade  practi¬ 
cally  never  exists  between  great  nations,  yet,  in  ordinary 
usance,  free  trade  is  said  to  exist  when  the  tariff  levied 
is  levied  according  to  strict  revenue  principles.  A 
strictly  revenue  tariff,  or  so-called  “free  trade,”  means, 

39 


40  ECONOMIC  ADVANTAGES  OF  COMMERCE 


then,  such  an  adjustment  of  taxes  as  will  not,  in  any 
great  degree,  divert  industry  in  the  levying  country  out 
of  the  channels  it  would  otherwise  follow,  i.e.  it  will 
so  divert  industry  to  the  least  possible  extent  consistent 
with  collection  of  the  needed  revenue.  A  tariff  levied 
by  any  country  only  on  goods  not  produced  within  it, 
is  such  a  tariff.  An  example  is  the  British  import  tax 
on  tea,  an  article  not  produced  in  Great  Britain  or  Ire¬ 
land.  An  import  duty  on  goods  which  are,  or  can  be, 
produced  within  the  levying  country,  is  also,  properly 
speaking,  a  revenue  duty,  if  it  is  accompanied  by  an 
internal  tax  of  equal  amount 1  on  the  domestic  product. 
Such  a  tax  does  not  have,  and  is  not  intended  to  have, 
any  great  effect  on  the  location  of  industry.  If  the 
domestic  producer  is  helped  by  the  tax  levied  on  imported 
goods,  he  is  hindered  to  an  approximately  equal  extent 
by  the  tax  laid  upon  his  own  goods.2  His  position  in 
relation  to  that  of  his  foreign  rivals  remains,  therefore, 
substantially  the  same  as  before. 

A  protective  tax  is  intended,  as  such,  primarily  to 
divert  industry  from  the  channels  it  would  otherwise 
follow  into  channels  favored  and  encouraged  by  the 
tariff  law.  Its  purpose  is  to  encourage  the  home  pro¬ 
ducer  in  some  line  or  lines  by  levying  a  high  tax  on 
goods  brought  from  abroad  and  thus  discouraging  the 
importation  of  such  goods. 

1  If  the  domestic  goods  are  of  identical  grade  and  therefore  of  the  same  value, 
a  tax  of  the  same  per  cent  is  also  a  tax  of  the  same  amount  per  unit  of  quantity. 
If  the  domestic  goods  are  of  different  grade  and  different  value,  the  question 
might  arise  whether  a  per  cent  tax  or  a  tax  per  unit  should  be  levied  equally  on 
both. 

2  Of  course  the  tax,  by  necessitating  a  higher  price,  may  decrease  the  total 
demand.  If  so,  both  home  and  foreign  producers  may  make  smaller  sales.  But 
so  far  as  the  public  still  buys  the  goods,  these  goods  are  produced  where  the  condi¬ 
tions  are  relatively  the  best. 


THE  INCIDENCE  OF  TARIFFS  FOR  REVENUE  41 


Expressing  the  matter  in  another  way,  we  may  say 
that  both  the  revenue  and  the  protective  tariff  are  taxes 
on  the  consumer ;  but  that  in  the  former  case  the  con¬ 
sumer  pays  this  tax  to  the  government,  while  in  the 
latter  he  pays  a  tax  to  the  home  producer.  A  revenue 
tariff  on  imports  can  only  be  successful  in  its  chief  aim 
if  it  allows  goods  to  be  imported,  because  on  all  such 
goods  a  tax  is  paid  which  goes  to  the  government  and 
may  be  used  for  public  purposes;  while,  on  the  other 
hand,  a  protective  tariff  is  most  successful  in  its  aim 
in  so  far  as  it  prevents  goods  from  being  imported,  be¬ 
cause  then  its  effect  is  to  raise  the  price  which  the  home 
producers  can  charge.  In  this  latter  case,  the  govern¬ 
ment  gets  little  or  no  revenue,  and  the  tax,  if  we  call 
it  such,  which  the  consumer  pays,  is  paid,  in  the  main, 
to  the  home  producers,  rather  than  to  the  government. 
In  other  words,  the  protective  tariff  makes  the  consumer 
buy  of  the  home  producer  at  prices  higher  than  the  home 
producer  could  otherwise  charge. 

§2 

When  the  Burden  of  an  Import  Duty  Levied  for  Revenue 
is  Borne  by  the  Levying  Country 

A  revenue  import  duty  is  commonly  supposed  to  be 
shifted  by  the  importers  on  whom  it  is  first  imposed,  to 
the  consumers,  in  the  levying  country,  of  the  taxed  goods. 
In  the  complications  of  modern  trade,  with  many  coun¬ 
tries  taking  part,  this  result  is  perhaps  very  nearly 
realized.  But  it  is  perhaps  never  exactly  realized,  and 
it  is  not  difficult  to  imagine  circumstances  under  which 
the  main  burden  of  the  tax  would  fall  elsewhere  than 
on  the  consuming  public  of  the  tariff  levying  country. 


42  ECONOMIC  ADVANTAGES  OF  COMMERCE 


Under  sufficiently  favorable  (to  the  levying  country) 
circumstances,  a  part,  or  all,  of  the  tax  might  fall  upon 
the  exporting  country,  or,  conceivably,  the  exporting 
country  might  lose  more  than  the  tax,  to  the  profit  of 
the  levying  country. 

Let  us,  in  discussing  the  various  possible  shiftings  of 
an  import  revenue  duty,  use  again  our  familiar  illus¬ 
tration,  the  assumed  trade  between  Ireland  and  Canada. 
If  Canada,  where  a  week’s  labor  will  produce,  according 
to  our  first  assumptions,  20  bushels  of  wheat  at  $1  a 
bushel  or  14  yards  of  linen  at  $1.43  a  yard,  levies  an 
import  duty  of  10  cents  a  yard  on  linen  from  Ireland, 
which  would  otherwise  sell  for  $1  a  yard,  this  linen  will 
sell  for  $1.10.  Irish  linen  will  still  be  bought  by  Cana¬ 
dians  in  preference,1  since  Canadian  linen  cannot  be 
sold  for  less  than  $1.43.  The  tax  is  levied  first  on  the 
importers.  The  importers  will  not,  perhaps  cannot, 
remain  in  business  if  they  are  unable  to  shift  the  tax, 
for  to  pay  it  themselves  will  make  their  profits  (if  these 
have  been  subject  to  competition  and  are  therefore 
approximately  the  same  as  in  other  kinds  of  business) 
less  than  the  same  labor  and  capital  will  yield  in  other 
lines,  and  will  very  likely  even  turn  them  into  losses. 
The  foreign  producers  will  not  (unless  combined  in  a 
monopoly  and  previously  earning  monopoly  profits, 
and  not  then  except  under  very  improbable  circum¬ 
stances  2)  consent  to  suffer  the  loss,  since  this  will  reduce 

1  If  there  is  any  likelihood  that  such  will  not  be  the  case,  and  if  the  tariff  is 
to  be  levied  for  revenue,  not  for  protection,  a  tax  as  great  should  be  placed  on 
the  home  produced  goods. 

2 1.t.  if  the  monopoly  will  lose  less  to  bear  the  whole  tax  than  to  shift  it  and  suf¬ 
fer  a  reduction  of  its  sales.  A  monopoly  will  itself  pay,  without  trying  to  shift, 
a  tax  levied  directly  on  monopoly  profits,  since  the  monopoly  can  best  pay  such  a 
tax  by  maintaining  the  same  prices,  i.e.  prices  yielding  the  highest  net  return. 
But  a  tax  which  increases  in  proportion  to  the  number  of  sales,  a  monopoly  will 


THE  INCIDENCE  OF  TARIFFS  FOR  REVENUE  43 


their  profits  below  the  average  level  in  their  country, 
in  other  lines.  The  supply  of  Irish  linen  offered  in 
Canada  will  not,  therefore,  equal  the  demand,  unless 
the  price  rises  by  10  cents  a  yard. 

If  the  demand  of  Canada  for  linen  is  absolutely  in¬ 
elastic,  the  shifting  proceeds  no  further;  the  10  cents 
a  yard  remains  as  a  continuing  burden  on  Canadian 
consumers  of  linen.  A  certain  amount  of  linen  was 
wanted  at  the  former  and  lower  price,  and  the  same 
amount  is  wanted  at  the  somewhat  higher  price.  The 
10  cents  additional  goes  to  the  Canadian  government. 
The  same  amount  as  before  must  be  paid  to  linen  manu¬ 
facturers  in  Ireland.  Canadian  wheat  prices  will  not 
change,  and  wheat  consumers  in  Ireland  will  buy  the 
same  amount  as  before  of  Canadian  wheat.  The  trade 
will  be  in  equilibrium  at  just  the  same  point,  as  to  quan¬ 
tity  of  money  in  each  country  and  as  to  amount  of  cloth 
required  to  buy  a  bushel  of  wheat,  as  before.  The  net 
result  is  to  take  10  cents  a  yard  from  each  Canadian 
purchaser  of  linen  imported  from  Ireland,  and  transfer 
this  10  cents  to  his  government.  If  we  omit  reference 
to  money  and  money  prices,  we  may  say  that  the  tax 
has  left  just  where  it  was  before,  the  rate  of  interchange 
between  the  two  commodities,  linen  and  wheat,  which 
equalized  supply  of  and  demand  for  each  in  terms  of 
the  other ;  and  that  the  Canadian  government  has  sim¬ 
ply  taken  in  taxation,  from  its  own  subjects,  a  part  of 
their  gain  from  the  trade. 

be  more  likely  to  endeavor  to  shift,  and  will  not  so  greatly  fear  a  resulting  de¬ 
crease  of  its  sales,  since  this  involves  a  decreased  tax  also. 


44  ECONOMIC  ADVANTAGES  OF  COMMERCE 

§  3 

When  the  Burden  of  an  Import  Duty  Levied  for  Revenue 

is  Shifted  by  the  Levying  Country  to  Another  or  to 

Other  Countries 

But  the  situation  is  otherwise  if  Canada’s  demand 
for  Irish  linen  is  elastic  while,  at  the  same  time,  Ireland’s 
demand  for  Canadian  wheat  is  inelastic.  If  the  demand 
of  Canada  for  linen  imported  from  Ireland  is  elastic, 
then  the  effect  of  the  ten  cents  tax,  in  raising  the  price 
of  the  linen  to  {i.ioa  yard,  will  be  to  decrease  the  Cana¬ 
dian  demand  for  the  linen.  In  consequence,  Canada 
will  have  a  smaller  money  obligation  to  Ireland.  Yet  if 
Ireland  continues  to  buy  as  much  wheat  as  before,  the 
yearly  money  obligations  from  Ireland  to  Canada  will 
be  the  same  as  if  the  tax  were  not  in  force.  There  will 
consequently  be  an  excess  flow  of  money  to  Canada. 
Canadian  prices  will  rise  and  Irish  prices  will  fall.  Of 
course,  if  the  Irish  demand  for  wheat  is  elastic,  or  if 
Ireland  can  as  cheaply  buy  her  wheat  elsewhere,  Ire¬ 
land’s  demand  for  wheat  will  fall  off  as  soon  as  the  price 
rises  very  slightly.  Then  there  can  be  little  redistribu¬ 
tion  of  the  money  metal,  and  Canada  can  shift  very 
little  of  the  tax  upon  Ireland.  The  net  result  is  less 
trade.  Canadians  buy  less  cloth  and  sell  less  wheat. 
But  if  the  Irish  demand  for  Canadian  wheat  is  inelastic, 
continuing  at  about  the  same  amount  despite  rise  of 
prices,  then  the  tax  may  seriously  decrease  Ireland’s 
gain  from  the  trade,  to  Canada’s  advantage. 

To  illustrate  this  possibility,  let  us  suppose  that,  in 
consequence  of  the  tax  on  linen  of  ten  cents  a  yard, 
which  raises  the  price  to  Canadian  consumers,  the  de¬ 
mand  for  linen  is  so  decreased  m  Canada  that  there  is 


THE  INCIDENCE  OF  TARIFFS  FOR  REVENUE  45 


a  net  inflow  of  gold  from  Ireland ;  and  let  us  suppose, 
further,  that  the  inflow  of  gold  does  not  cease  until  the 
supply  of  money  in  Canada  is  of  its  former  amount, 
and  that  of  Ireland  of  what  it  was.  Then  Cana¬ 
dian  wheat  would  sell  for  of  $1  or  about  $1.09 
a  bushel,  while  Irish  linen,  not  counting  the  tax,  would 
sell  for  $0.90  instead  of  $1  per  yard,  or,  with  the  ten 
cents  tax,  at  $1  instead  of  $1.10.  Let  us  suppose  that, 
at  this  new  set  of  prices,  Canada  again  has  to  pay  Ire¬ 
land  as  much  for  linen  each  year  as  Ireland  has  to  pay 
Canada  for  wheat. 

How  does  the  case  stand  as  to  gains  and  losses  of 
the  two  communities  ?  The  Canadians  are  still  getting 
their  linen  for  $1  a  yard,  the  price  without  the  tax  hav¬ 
ing  fallen  to  $0.90.  And  they  are  getting  $1.10  a  bushel 
for  wheat  instead  of  $1.  The  Canadian  government 
is  securing  its  ten  cents  tax  on  every  yard  of  linen ;  yet 
Canadian  consumers  are  paying  no  more  than  before 
the  tax  was  laid,  and  Canadian  producers  are  getting 
a  higher  price  for  their  wheat.  The  people  of  Ireland 
are  paying  to  Canada  the  tax  and  more  than  the  tax.1 
The  linen  manufacturing  interests  of  Ireland  are  receiv¬ 
ing  $0.90  instead  of  $1  a  yard  for  their  linen ;  they 
are  paying  more  for  wheat.  It  is  still  worth  while  for 
them  to  engage  in  the  trade.  They  can  still  secure  more 
wheat  in  exchange  for  a  week’s  production  of  linen  than 
they  can  themselves  produce  in  a  week  (except  on  their 
best  lands).  But  they  gain  much  less  from  the  trade 
than  formerly.  It  should  be  added  that  the  taxing 
country,  Canada,  may  gain  also  in  lower  prices  of  other 
Irish  goods  than  linen  cloth,  resulting  from  the  redis¬ 
tribution  of  money,  and  in  their  ability  to  buy  more  of 

1  Mill,  Principles  of  Political  Economy,  Book  V,  Ch.  IV,  §  6. 


46  ECONOMIC  ADVANTAGES  OF  COMMERCE 

these  goods  because  of  the  lower  prices  and  their  own 
higher  incomes. 

We  must  guard  ourselves  against  the  assumption  that 
the  whole  loss  falls  upon  the  Irish  linen  manufacturing 
population  as  distinguished  from  Irish  producers  in 
other  lines.1  The  loss  is  general.  The  linen  producers 
would  not  remain  in  that  business  and  alone  bear  all 
the  loss,  since  labor  and  capital  tend  always  to  leave 
relatively  unprofitable  for  relatively  profitable  activities. 
They  only  sell  linen  more  cheaply  because  of  a  decrease 
of  money  in  Ireland,  which  tends  to  lower  in  a  like  pro¬ 
portion  the  prices  of  all  Irish  goods  and  Irish  labor.2 
Likewise,  the  higher  price  of  Canadian  wheat  falls  alike 
on  all  consumers  of  it  in  Ireland. 

On  one  hypothesis,  however,  the  price  of  linen  made 
in  Ireland  would  fall  by  a  greater  per  cent  than  other 
Irish  prices,  viz.  on  the  hypothesis  (likely  to  be  in  con¬ 
formity  with  fact)  that  the  profits  of  linen  production 
are  greater  in  some  factories  and  on  some  sites  in  Ire¬ 
land  than  on  other  sites  in  that  country.  If  the  tax 
decreases  the  demand  for  the  linen  in  Canada,  the  Irish 
manufacturers  on  the  better  sites  may  alone  be  able 
to  satisfy  the  demand  remaining;  and  they  may  be 
willing  to  do  so,  because  of  their  relatively  advanta- 

1  Mill,  Principles  of  Political  Economy,  Book  V,  Ch.  IV,  §  6. 

2  Strictly  speaking,  a  tV  decrease  of  money  in  Ireland  would,  under  the  con¬ 
ditions  here  assumed,  cause  a  fall  in  the  prices  of  Irish  goods,  of  more  than 
For  it  would  cause  a  fall  of  in  average  prices,  including  the  price  of  Canadian 
wheat  and  its  products  so  far  as  bought  and  sold  in  Ireland,  e.g.  by  middlemen. 
Since  these  goods  would  be  higher  in  price,  other  goods  must  fall  in  greater  pro¬ 
portion  than  io  per  cent.  Whether  the  fall  in  the  prices  of  other  goods  would 
be  much  greater  than  io  per  cent,  would  depend  upon  the  importance,  in  the 
Irish  market,  of  the  Canadian  product.  If  trade  with  Canada  is  assumed  to 
be  of  slight  importance,  other  prices  would  fall  by  about  A,  otherwise  by  more. 
But  no  good  purpose  would  be  served  by  complicating  the  text  with  these  re¬ 
finements. 


THE  INCIDENCE  OF  TARIFFS  FOR  REVENUE  47 


geous  positions,  at  prices  lower  than  could  be  afforded 
by  marginal  manufacturers  ( e.g .  those  on  the  poorest 
sites),  rather  than  go  into  other  occupations.  The  loss 
to  Ireland,  due  to  Canada’s  tax,  would  then  fall  with 
greatest  weight  on  the  linen  producers  of  Ireland,  or 
on  the  owners  of  sites  adapted  to  linen  manufacture. 
A  surplus  gain,  from  better  organization  or  from  more 
advantageous  situation,  which  these  classes  had  pre¬ 
viously  enjoyed,  would  be  lessened. 

As  regards  the  ultimate  burden  of  the  tax,  we  reach 
no  different  conclusion  if  we  assume  the  currencies  of 
Ireland  and  Canada  to  be  based  on  independent  standards 
and  prices  in  the  one  country  to  be  entirely  unrelated 
to  prices  in  the  other.1  Suppose  each  to  have  a  paper 
money  standard,  not  redeemable  in  gold.  The  ten 
cents  tax  discourages  Canadian  purchase  of  Irish  linen. 
Ireland  continues  to  buy  about  the  usual  amount  of 
Canadian  wheat.  The  balance  is  settled  in  gold.  In 
Ireland,  gold  becomes  scarcer  and  has  more  purchasing 
power;  in  Canada,  it  becomes  more  plentiful  and  has 
less  purchasing  power,  per  unit  quantity.  Irish  paper 
money  will  buy  less  gold.  Canadian  paper  money  will 
buy  more  gold.  Canadian  wheat  remains  $1  a  bushel 
in  terms  of  Canadian  money,  but  it  requires  more  gold 
than  before  to  buy  it,  and  more  Irish  money  to  buy  the 
gold.  The  cost  to  the  people  of  Ireland  of  Canadian 
goods  tends  to  rise.  The  cost  to  Canadians  of  the 
products  of  Ireland  tends  to  fall.  Omitting,  altogether, 
consideration  of  money  prices,  we  may  say  that  the 
tax,  by  discouraging  Canadians  from  trading,  has  made 
necessary  a  new,  and,  for  Canada,  a  more  favorable 
rate  of  interchange  of  goods,  to  equalize  supply  and 
demand. 

1  Cf.  Part  I,  Ch.  VI,  §§  6,  7,  8,  9. 


48  ECONOMIC  ADVANTAGES  OF  COMMERCE 


The  illustrative  figures  which  have  been  given  show 
a  loss  to  Ireland  greater  than  the  amount  of  Canada’s 
tax.1  -Ireland’s  loss,  however,  might  be  the  equivalent 


1  Professor  Edgeworth  seems  to  take  the  view  ( Economic  Journal,  Vol.  VII, 
p.  397)  that  this  extreme  possibility  is  a  consequence  of  the  tax  being  collected, 
in  practice,  in  money,  and  that  if  it  were  collected  in  kind,  Ireland  (in  our  ex¬ 
ample)  could  not  be  made  to  pay  more  than  the  tax.  His  thought  apparently 
is  that,  however  elastic  Canada’s  demand  for  linen,  if  Ireland  paid  the  tax  in 
linen,  in  addition  to  giving  Canadian  consumers  as  much  linen  as  before  for  the 
same  amount  of  wheat  as  before,  the  trade  would  again  be  in  equilibrium ;  that 
the  Canadian  consumers,  as  distinguished  from  the  government,  would  then  be 
entirely  unaffected  by  the  tax,  and  would  be  as  willing  to  buy  linen  with  wheat 
as  previously  and  in  as  large  quantities ;  and  that  Ireland,  therefore,  would  not 
have  to  pay  more  than  the  tax  to  get  the  accustomed  supply  of  wheat  from 
Canada. 

A  correct  distinction  between  the  circumstances  under  which  more  than  the 
burden  of  the  tax  might  conceivably  be  shifted  upon  Ireland  and  the  circum¬ 
stances  under  which  the  full  amount  of  the  tax  would  be  the  limit  of  this  burden, 
is  based  on  what  the  Canadian  government  does  with  the  tax  and  not  at  all  on 
whether  it  is  initially  collected  in  money  or  in  kind.  We  may  rightly  conclude 
that  a  Canadian  import  tax  collected  in  linen  could  not  impose  a  greater  burden 
upon  Ireland  than  the  amount  of  the  tax,  if  we  suppose  the  Canadian  govern¬ 
ment  to  throw  the  linen  it  receives  as  taxes  into  the  sea  or  if  we  assume  that  it 
uses  the  linen  so  received  for  a  purpose  which  would  otherwise  not  be  carried 
out.  We  may  reach  exactly  the  same  conclusion  with  equal  certainty,  however, 
if  we  suppose  the  tax  to  be  initially  collected  in  money  and  the  money  then  used 
to  buy  the  linen  to  be  disposed  of  in  one  of  these  two  ways.  If  the  burden  of  this 
tax  collected  in  money  falls  entirely  upon  Ireland,  then  Ireland  must  sell  enough 
more  linen  (assuming  she  has  no  other  exports)  to  pay  it.  But  the  Canadian 
government  expends  the  entire  money  returns  from  the  tax  for  linen  which, 
otherwise,  by  our  present  hypothesis,  the  government  would  not  buy.  In 
other  words,  Canada  buys  as  much  more  linen  as  Ireland  must  sell  additional 
to  pay  the  tax.  If  Ireland,  therefore,  thus  bears  the  entire  burden  of  the 
tax  by  exporting  extra  linen,  the  remainder  of  her  linen  will  find  the  same 
market  as  previously  and  will  bring  her  as  much  wheat  as  before. 

But  if  the  Canadian  government  would  use  about  the  same  amount  of  linen 
anyway,  then  for  the  government  to  get  this  linen  by  taxing  linen  imports  in 
kind  (and  likewise  by  taxing  them  in  money)  instead  of  by  purchasing  the  de¬ 
sired  linen  with  the  proceeds  of  internal  taxes,  means  that,  whereas  the  govern¬ 
ment  before,  in  effect,  offered  say  wheat  (if  the  money  equivalent  is  offered,  our 
conclusion  would  be  the  same)  taken  in  taxes  for  the  desired  linen,  now  it  offers 
nothing.  Both  individual  Canadian  consumers  and  the  Canadian  government 
had  been  offering  wheat  for  linen.  Now  only  the  former  are  doing  so.  The 
people  of  Ireland,  if  the  Canadian  wheat  is  necessary  for  them,  must  now  buy 
as  much  wheat  with  linen  (assuming  them  to  have  nothing  else  exportable)  from 


THE  INCIDENCE  OF  TARIFFS  FOR  REVENUE  49 


of  the  tax,  or  it  might  be  considerably  less  than  the  tax. 
Thus,  the  equilibrium  of  trade  might  be  restored  when 
Canadian  wheat  had  gone  up  to  $1.03  a  bushel,  and 
Irish  linen  down  to  $0.96  a  yard,  making  $1.06  with  the 
tax.  Then  Canadians  would  be  paying  6  cents  of  the 
10  cents  tax  on  each  yard,  but  getting  back  3  cents 
of  it  in  the  higher  price  of  wheat.  Ireland  would  be 
paying  the  larger  part  of  the  tax,  but  Canada  would 
have  failed  to  shift  all  of  it  upon  Ireland. 

Two  conditions,  then,  or  sets  of  conditions,  favor  the 
tax-levying  country  in  any  attempt  to  shift  the  burden 
of  the  tax  upon  the  country  trading  with  it.  In  the 
first  place,  the  tax-levying  country  is  advantaged  by 

the  Canadian  people  individually  as  they  previously  bought  from  individual 
Canadians  and  the  Canadian  government  together.  If  the  Canadian  people, 
as  individuals,  have  a  comparatively  elastic  demand  for  linen,  Ireland  must  offer 
them  for  their  individual  consumption,  besides  what  their  government  gets, 
about  as  much  linen  as  before  per  bushel  of  wheat  or  they  will  not  trade  to  any¬ 
thing  like  the  former  extent.  Ireland  must  therefore  pay  most  or  all  of  the  tax. 
But  Ireland  will  then  only  be  getting  the  wheat  she  previously  got  from  Cana¬ 
dians  as  individuals  and  will  not  be  getting  what  she  previously  got  as  a  result 
of  her  trade  with  the  Canadian  government.  This  additional  amount  she  must 
now  get  (for  we  are  supposing  her  demand  to  be  inelastic)  from  Canadians  as 
individuals,  and  to  do  so  she  must  sell  more  linen.  The  result  may  be,  even 
though  Canada’s  demand  for  linen  is  somewhat  elastic,  that  the  marginal  utility 
of  linen  to  Canadian  consumers  falls,  and  that  Ireland  must  offer  more  than 
before,  per  bushel  of  wheat,  besides  paying  the  tax. 

It  is  true  that  if  Canadians  are  released  from  a  tax  they  themselves  previously 
paid,  they  may  want  more  linen  than  before,  but  the  probability  is  that  their 
greater  prosperity  so  resulting  would  be  enjoyed  in  other  ways  also  and  would 
but  slightly  affect  their  demand  for  linen.  And  unless  the  entire  gain  from 
remission  of  the  taxes  formerly  spent  by  the  government  for  linen  were  now 
spent  by  the  Canadian  people  for  additional  linen  beyond  their  previous  indi¬ 
vidual  consumption,  the  new  demand  resulting  from  their  greater  prosperity 
would  not  take  the  place  of  the  former  demand  by  their  government. 

We  cannot  safely  conclude,  therefore,  that  if  the  tax  is  collected  in  kind, 
Ireland  cannot  possibly  lose  more  than  its  equivalent.  As  is  shown  in  the  text, 
any  great  shifting  of  taxes  to  foreign  nations  is  rather  a  theoretical  possibility 
than  a  practical  probability,  but  if  it  is  a  theoretical  possibility  when  collected 
in  money,  it  is  also  a  theoretical  possibility,  and  to  the  same  extent,  when  col¬ 
lected  in  kind. 


PART  n  —  E 


50  ECONOMIC  ADVANTAGES  OF  COMMERCE 


having  a  very  elastic  demand  for  the  goods  of  the  other, 
coupled  with  monopoly  of  consumption  of  the  goods 
of  the  other.1  In  the  second  place,  the  tax-levying  coun¬ 
try  is  aided  if  it  has  a  monopoly  of  production  of  the 
goods  it  sells  while  the  other  country  has  an  inelastic 
demand  for  those  goods.2 

In  practice,  the  conditions  under  which  a  country  can 
shift  all  or  most  of  its  import  taxes  upon  another,  are 
unlikely  to  occur,  or,  at  least,  are  unlikely  to  occur  in 
conjunction.  To  begin  with,  we  cannot  expect  that, 
in  general,  the  country  exporting  the  taxed  product  will 
have  an  inelastic  demand  for  the  product  or  products 
of  the  taxing  country.  And,  secondly,  a  very  slight 
change  in  relative  prices  may  bring  additional  articles 
within  the  demand  of  the  taxing  country,  thus  main¬ 
taining  the  equilibrium  of  trade  nearly  where  it  was 
before.  To  illustrate,  a  slight  rise  of  Canadian  prices 
and  a  slight  fall  of  Irish  prices  may  induce  Canadians 
to  buy  potatoes,  silks,  and  laces,  as  well  as  linen,  in  Ire¬ 
land.  Then  equilibrium  may  result  without  a  sufficient 
change  in  the  rate  of  trade  to  throw  upon  Ireland  much 
of  the  burden  of  the  import  tax. 

Thirdly,  and  probably  most  important  of  all,  the 
taxing  country  cannot  ordinarily  shift  much  of  the  bur¬ 
den  of  its  import  duties  to  another,  because  third  coun¬ 
tries  offer  to  this  other  a  competing  or  alternative  trade. 
Thus,  Canada  probably  cannot  throw  upon  Ireland 
the  burden  of  a  tax  on  Canada’s  imports,  because  Ire¬ 
land  has  the  alternative  of  trading  with  India,  Argentina, 
the  United  States,  and  other  countries.  If  Canada 
buys  less  Irish  linen  because  of  the  tax,  so  that  money 

1  Bastable,  The  Theory  of  International  Trade,  fourth  edition,  London  (Mac¬ 
millan),  1903,  p.  116.  3  Ibid.,  pp.  116,  117. 


THE  INCIDENCE  OF  TARIFFS  FOR  REVENUE  51 


flows  into  Canada  and  Canadian  prices  rise,  Ireland 
will  buy  wheat  of  India,  the  United  States,  Argentina, 
or  Russia,  rather  than  pay  higher  prices  for  Canadian 
wheat.  In  short,  the  Canadian  wheat  producers  must 
take  the  same  prices  charged  elsewhere,  or  export  no 
wheat.1  Likewise,  rather  than  sell  their  linen  to  Canada 
for  a  much  lower  price  than  before,  the  people  of  Ireland 
would  export  more  to  other  markets.  Most,  if  not  all, 
of  the  tax  would  be  pretty  likely  to  fall  upon  the  people 
of  the  taxing  country;  and  even  if  this  were  not  true, 
the  attempt  to  tax  other  nations  is  a  game  at  which  all 
can  play. 

The  fact  that  other  countries  than  Ireland  and  Canada 
are  to  be  reckoned  with,  means,  also,  that  the  general 
price  level  in  Ireland  would  probably  fall  very  little  as 
a  consequence  of  Canada’s  tax.  Though  an  inflow  of 
money  into  Canada  due  to  her  decreased  imports  might 
somewhat  raise  the  level  of  Canada’s  prices,  any  corre¬ 
sponding  fall  in  Irish  prices  would  make  Ireland  a  good 
place  to  buy  in  and  would  cause  money  to  flow  from 
third  and  fourth  countries  into  Ireland,  even  if  Cana¬ 
dians  were  prevented  by  their  import  tax  from  buying 
in  Ireland.  The  fall  of  prices  would,  then,  if  it  took 
place,  be  distributed  over  several  countries  and  would 
not  probably  be  confined  to  Ireland.  It  would  be  very 
slight,  therefore,  in  any  country.  The  chief  effect  of 
the  redistribution  of  gold  consequent  on  Canada’s  tax 
would  be  seen  in  a  rise  of  Canadian  prices  and  not  in  a 
fall  of  Irish  prices. 

1  The  exact  effect,  in  the  absence  of  any  disturbing  factors,  would  be  a  trans¬ 
ference,  in  part,  of  the  Irish  demand  for  wheat  to  these  other  countries;  a  very 
slight  increase,  generally,  of  the  price  of  wheat,  and,  therefore,  a  very  slight 
increase  of  the  price  of  the  Canadian  wheat  still  exported;  and  a  very  slight 
decrease  in  the  price  received  by  Ireland  for  linen. 


52  ECONOMIC  ADVANTAGES  OF  COMMERCE 

§4 

The  Ultimate  Incidence  of  a  Revenue  Duty  on  Exports 

Duties  for  revenue  may  be  levied  on  exports,  if  so 
desired,  as  well  as  on  imports,  though  the  present  prac¬ 
tice  is  to  levy  them  on  imports.  Here,  again,  there  are 
various  possibilities  as  to  shifting.  Suppose  that  Canada 
levies  a  duty  of  ten  cents  a  bushel  on  the  export  of  wheat. 
The  production  of  wheat,  in  Canada,  for  export,  would 
be  decreased,  unless  the  tax  could  be  shifted  upon  foreign 
consumers.  If  the  tax  could  not  be  shifted,  those  wheat 
producers  who  were  making  but  the  usual  return  to 
industry  (the  marginal  producers)  would  change  to 
another  line  of  production.  If  the  wheat  consumers 
of  Ireland  (and  of  other  countries  getting  their  wheat 
from  Canada)  should  have  an  absolutely  inelastic  demand 
for  wheat  and  could  get  wheat  nowhere  else,  they  would 
pay  the  higher  price  for  wheat  rather  than  not  get  the 
usual  amount  of  it,  and  thereby  would  be  paying  the 
tax.  In  fact,  if  their  demand  were  altogether  inelastic, 
they  would  soon  be  paying  more  than  the  tax.1  For 
the  whole  amount  paid  by  purchasers  of  Canadian  wheat, 
including  the  part  collected  by  the  Canadian  govern¬ 
ment  as  export  tax,  goes  to  Canada.  This  means  that 
if  the  wheat  consumers  of  Ireland  (and  elsewhere)  paid 
the  tax  in  addition  to  what  they  were  previously  paying, 
there  would  be  a  flow  of  gold  into  Canada.  Canadian 
prices  would  rise.  Prices  in  Ireland  would  fall.  Con¬ 
sumers  in  Ireland  would  then  be  paying  more  for  wheat 
by  the  amount  of  the  tax  plus  the  amount  of  rise  (due 
to  gold  flow)  of  net  price ;  while  the  fall  of  Irish  prices 
would  mean  cheaper  linen  for  Canada.  A  bushel  of 

1  Mill,  Principles  of  Political  Economy,  Book  V,  Ch.  IV,  §  6. 


THE  INCIDENCE  OF  TARIFFS  FOR  REVENUE  53 


wheat,  even  after  subtraction  of  the  tax,  would  buy 
more  linen  than  before. 

But  if  Ireland’s  demand  for  wheat  is  decidedly  elastic, 
or  can  be  easily  satisfied  from  other  sources  of  supply, 
then  the  increased  price  resulting  from  the  export  tax 
will  cause  an  immediate  falling  off  of  Irish  purchases. 
Let  us  suppose  this  falling  off  of  Irish  demand  to  be 
sufficient  so  that,  even  with  the  addition  to  the  price, 
of  the  tax,  the  money  obligations  from  Ireland  to  Canada 
are  less  than  before.  Then  a  balance  of  gold  will  flow 
from  Canada  to  Ireland.  Canadian  prices  will  fall 
and  prices  in  Ireland  rise.  If  Canadian  demand  for 
linen  is  comparatively  inelastic,  this  flow  and  change  of 
prices  may  go  to  a  considerable  extent  before  Canadian 
demand  for  linen  decreases  and  Irish  demand  for  wheat 
(and  other  Canadian  products)  increases  enough  to 
bring  equilibrium.  At  any  rate,  the  fall  of  Canadian 
and  rise  of  Irish  prices  will  mean  that  at  least  a  part  of 
Canada’s  export  tax  has  been  shifted  back  upon  Canada. 
It  is  conceivable  that  Canadian  wheat  will  fall  so  far 
in  price  that,  even  with  the  tax,  Ireland  gets  it  as  cheaply 
as  or  more  cheaply  than  before,  while  Canada  pays  more 
for  Irish  linen.  In  that  case,  Canada,  so  far  from  taxing 
another  country  or  other  countries,  would  herself  lose 
more  than  the  tax.  If  we  assume  Canada  and  Ireland 
to  have  different  standards  of  value,  our  conclusions 
will  be  the  same.1 

It  should  be  clearly  understood  that  the  loss  to  Canada 
(assuming  the  result  just  discussed)  does  not  fall,  if  the 
taxed  article  is  produced  at  nearly  constant  cost,  on  the 
producers  of  that  article  alone.  For  these  producers 
would  refuse  to  accept  lower  returns  and  remain  in  the 

1  Cf.  §  3  of  this  chapter  (III  of  Part  II). 


54  ECONOMIC  ADVANTAGES  OF  COMMERCE 


same  business  when  other  lines  were  more  profitable. 
They  accept  the  lower  prices  when  and  because  the 
outflow  of  money  makes  Canadian  prices,  generally, 
lower. 

But  the  goods  taxed  may  be  produced  under  condi¬ 
tions  of  sharply  increasing  cost  (i.e.  by  some  producers 
less  advantageously  than  by  others) .  This  may  be  the 
case  with  wheat,  chosen  as  our  illustration  of  the  taxed 
article.  On  this  assumption,  much  of  the  loss  due  to 
the  tax  may  fall  on  the  owners  of  wheat  lands.  Those 
producing  at  the  margin  of  cultivation  (those  just  mak¬ 
ing  enough  to  keep  them  in  the  industry)  will  refuse  to 
bear  this  loss,  and  will  cease  producing.  Those  producing 
under  more  favorable  circumstances  (on  more  fertile 
or  better  situated  land)  may  prefer  to  suffer  consider¬ 
able  loss  out  of  what  would  have  been  their  surplus  or 
rent,1  rather  than  to  cease  wheat  raising.2  After  the 
tax  has  diminished  foreign  demand  for  Canadian  wheat, 
the  more  advantageously  situated  Canadian  wheat 
producers  can  fill  this  smaller  demand  at  lower  net 
prices  than  before,  and  still  realize,  because  of  their 
advantages  of  soil  and  situation,  a  reasonable  profit.  A 
price  sufficient  to  keep  the  poorer  situated  producers 
in  business,  plus  the  tax,  will  not  be  paid  by  enough 
foreign  consumers  to  take  the  previous  annual  supply 
of  Canadian  wheat.  The  price  will  fall.  Canadian 
owners  of  wheat  lands  will  derive  a  smaller  return  from 
those  lands.  If  there  is  a  surplus  flow  of  gold  from 
Canada,  because  of  excess  purchases  of  Irish  linen  over 
sales  of  Canadian  wheat,  the  price  of  the  wheat  will 
fall  still  further,  along  with  prices  of  other  Canadian 

1  Cf.  Bastable,  The  Theory  of  International  Trade,  p.  114. 

2  Cf.  Ch.  II  (of  Part  II),  §  4. 


THE  INCIDENCE  OF  TARIFFS  FOR  REVENUE  55 


goods.  But  it  will  still  be  true  that  a  special  loss  has 
fallen  upon  the  owners  of  wheat  lands.1 

As  in  the  case  of  the  import,  so  in  the  case  of  the  export 
revenue  tax,  we  must  emphasize  the  unlikelihood  that 
a  country  will  be  able  to  shift  the  principal  part  of  its 
tax  burden  upon  other  countries.  So  soon  as  trade 
with  Canada  becomes,  because  of  the  tax,  appreciably 
less  profitable  to  Ireland,  the  latter  country  is  likely 
to  trade  more  with  other  nations  and  communities,  and 
less  with  Canada.  For  this  reason  particularly,  as  well 
as  the  fact  that  the  other  country,  Ireland,  is  quite  as 
likely  as  the  tax-levying  country,  to  have  an  elastic 
demand  for  the  goods  it  imports,  there  is  a  reasonable 
probability  that  the  people  of  each  country  will  them¬ 
selves  have  to  pay,  in  the  main,  the  cost  of  running  their 
own  government  and  carrying  on  its  functions. 

§5 

Summary 

Revenue  tariffs  we  have  classified  as  import  and  export 
tariffs.  A  revenue  tariff,  as  such,  is  expected  to  secure 
revenue  for  government  with  the  least  possible  effect 
on  industry.  A  protective  tariff  is  specifically  intended 
to  turn  industry  into  channels  it  would  otherwise  not 
enter. 

Revenue  tariffs  on  imported  goods  may  fall  on  the 
consumers  in  the  tax-levying  country,  or  may,  under 
certain  hypothetical  circumstances,  fall  upon  the  country 
(or  countries)  exporting  the  taxed  goods.  If  the  demand 
for  the  goods  in  the  taxing  country  is  elastic ;  if  the 

1  In  a  similar  way  it  might  be  shown  that,  even  if  Canada  succeeds  in  throw¬ 
ing  the  main  burden  of  the  tax  upon  Ireland,  owners  of  Canadian  wheat  lands 
might,  as  a  separate  class,  have  their  prosperity  decreased. 


56  ECONOMIC  ADVANTAGES  OF  COMMERCE 

demand  for  the  goods  produced  in  it  is  in  other  coun¬ 
tries  comparatively  inelastic ;  and  if  these  other  coun¬ 
tries  have  no  other  place  to  sell  their  exports  and  buy 
the  goods  they  desire ;  then  the  tax  burden  may  be 
shifted  in  part,  or  in  whole,  or  more,  upon  them.  But 
in  the  actual  commercial  world,  circumstances  are  not 
likely  thus  to  favor  the  tax-levying  country. 

In  the  case  of  tariffs  on  exported  goods,  the  hypotheti¬ 
cally  possible  consequences  are  not  dissimilar.  A  suffi¬ 
ciently  inelastic  demand  from  other  countries,  for  the 
taxed  goods,  will  throw  upon  them  a  burden  perhaps 
equal  to  or  in  excess  of  the  tax,  to  the  advantage  of  the 
taxing  country.  On  the  other  hand,  the  country  taxing 
its  exports  may,  if  the  foreign  demand  for  the  taxed 
goods  is  elastic  while  its  demand  for  foreign  goods  is 
inelastic,  not  only  pay,  itself,  the  entire  tax,  but  may  also 
carry  on  its  trade  with  foreign  countries  at  a  less  favor¬ 
able  rate  of  interchange  to  it,  than  before.  The  general 
rule  probably  is  that  a  government  is  mainly  supported 
by  those  subject  to  it.  If  it  were  possible  to  support 
government  by  shifting  taxes  upon  foreign  countries, 
all  nations  would  be  likely  to  attempt  it,  with  consequent 
cancellation  or  partial  cancellation  of  effects. 


CHAPTER  IV 


The  Effect  of  a  Protective  Tariff  on  National 

Wealth 


The  Effect  of  a  Protective  Tariff  on  a  Country's  Export 

Trade 


In  discussing  the  protective  tariff,  a  natural  starting 
point  is  the  question  of  its  effect  on  the  supply  of  goods 
brought  from  foreign  countries.  A  purely  revenue  tariff 
is  intended  to  have  the  least  possible  effect  on  the  flow 
of  trade.  A  protective  tariff  prevents  goods  from  coming 
into  the  “ protected”  country,  is,  in  fact,  particularly 
intended  so  to  do,  by,  in  effect,  fining  the  importers. 
Thus,  a  Canadian  tariff  on  linen  of  50  cents  a  yard 
may  be  said  to  fine  the  importers  of  linen  to  that  extent. 
This  discourages  importation  and  so  tends  to  decrease, 
in  Canada,  the  supply  of  linen.  In  consequence  of  the 
decreased  supply  of  linen  in  Canada,  the  price  advances. 
Either  it  must  advance  by  about  the  equivalent  of  the 
tax,1  or  the  linen  will  not  be  imported.  This  high  price, 
however,  causes  a  falling  off  in  the  demand  for  linen 
brought  from  abroad,  and  a  shifting  of  this  demand 
to  the  home  product.  If  linen  from  Ireland  was  $1.00 
and  cannot  now  be  sold  for  less  than  $1.50,  and  if  Cana¬ 
dians  can  manufacture  it  profitably  for  $1.43,  the  sales 

1  See,  however,  discussion  in  this  chapter  (IV  of  Part  II),  §§  6  and  7.  Cf. 
Ch.  Ill  (of  Part  II),  §  3. 


57 


58  ECONOMIC  ADVANTAGES  OF  COMMERCE 


of  Canadian  linen  in  Canada  will  increase.  Canadian 
production  is  thus  encouraged,  by  government  aid,  to 
follow  a  line  which  it  otherwise  would  not. 

This  purposeful  interfering  with  importation  disturbs 
the  previously  existing  equilibrium  of  trade  conditions. 
Canada,  for  a  time,  continues  to  export  wheat  or  other 
goods,  though  refusing  to  import  much  linen.  Gold, 
therefore,  flows  out  of  Ireland  and  into  Canada.  This 
raises  Canadian  prices  and  lowers  prices  in  Ireland.1 
The  prices,  therefore,  of  goods  which  Canada  has  ex¬ 
ported,  e.g.  wheat,  may  rise  so  high  that  the  Irish  and 
other  foreign  demand,  if  it  does  not  cease,  will  at  least 
grow  smaller.  Or,  if  some  of  these  goods,  such  as  wheat, 
cannot  be  sold  abroad  even  in  smaller  quantities  for  a 
higher  price  than  before,  because  of  competition  from 
other  sources  of  supply,  then  the  higher  money  cost  of 
production  in  Canada  will  cause  production  for  a  foreign 
market  to  decrease.  In  the  long  run,  by  so  much  as  a 
protective  tariff  directly  limits  imports,  by  just  so  much 
will  it  indirectly  injure  the  levying  country’s  export 
trade.2  This  is  true  whether  the  different  trading  coun- 


1  Or,  if  there  is  a  general  tendency  for  prices  to  fall,  as  from  a  more  rapid 
increase  of  trade  than  of  money,  Canadian  prices  fall  less  than  do  Irish  prices ; 
while,  if  there  is  a  general  tendency  for  prices  to  rise,  Canadian  prices  rise  more 
than  Irish  prices.  The  essential  fact  is,  that  Canadian  prices  rise  by  comparison 
with  Irish  prices,  while  Irish  prices  fall  by  comparison  with  Canadian  prices.  It 
would  complicate  and  make  harder  to  follow  our  arguments  to  add  this  expla¬ 
nation  in  each  chapter  throughout  Parts  I  and  II,  but  the  reader  may,  with 
advantage,  bear  it  in  mind. 

2  Whatever  goods  continue  to  be  exported  until  Canadian  prices  have  appre¬ 
ciably  risen,  would  more  probably  be  goods  produced  under  conditions  of  in¬ 
creasing  cost  and  goods  in  which  competition  from  other  sources  of  supply  would 
not  prevent  Canadian  sales  even  at  somewhat  higher  prices  than  before.  If 
all  goods  were  produced  under  conditions  of  absolutely  constant  cost  and  could 
be  secured  equally  well  from  other  sources,  if  society  were  in  a  state  of  economic 
equilibrium,  and  if  there  were  no  economic  friction,  then  Canadian  prices  could 
change  only  infinitesimally  as  a  result  of  money  inflow  caused  by  the  tariff.  For 


PROTECTION  AND  NATIONAL  WEALTH  59 


tries  have  a  common  standard  of  value,  or  unrelated 
monetary  systems,  or  no  monetary  systems.  The 
Irish  manufacturers  of  linen  will  be  forced  by  the  more 
direct  action  of  the  tariff  to  seek  markets  elsewhere 
than  in  Canada.  The  Irish  consumers  of  wheat  will 
soon  make  use  of  the  alternative,  in  case  an  inflow  of 
gold  into  Canada  raises  wheat  prices  there  (or,  if  the 
currencies  are  unrelated,  in  case  more  Irish  money  than 
before  is  required  to  buy  a  given  amount  of  Canadian 
money),  of  buying  their  wheat  elsewhere.  The  result,  to 
Canada,  is  the  loss  of  what  had  been  a  profitable  trade. 

The  establishment  of  a  few  protected  industries  may 
serve  to  discourage  or  cripple  many  unprotected  indus¬ 
tries,  for  it  means  higher  money  prices  and  a  consequent 
disadvantage  to  all  lines  of  export  trade.  Among  other 
things,  the  services  of  a  country’s  mercantile  marine 
may  be  regarded  as  exports  of  that  country,  in  so  far  as 
these  services  are  rendered  to  and  are  paid  for  by,  the 
people  of  other  countries.  This,  like  other  parts  of  a 
country’s  export  trade,  is  affected  unfavorably  if  the 
country  follows  the  protective  tariff  policy.  Besides 
the  injurious  effect  resulting  from  the  general  rise  of 
money  prices  in  the  protected  country,  on  the  exporta¬ 
tion  of  any  of  that  country’s  products,  there  is  the  special 
discouragement  which  results  if  the  production  of  these 
exportable  goods  requires  the  use  of  machinery  or  raw 
material  directly  raised  in  price  by  a  tariff  upon  it. 

the  least  tendency  to  rise  of  costs  would  at  once  turn  all  producers  away  from 
lines  of  production  for  a  foreign  market  in  which  prices  could  not  be  made  to 
rise  equally  fast,  and  prices  in  foreign  markets,  of  the  goods  in  question,  would 
not  rise  if  the  goods  could  be  secured  in  larger  quantity  from  other  sources,  at 
no  greater  cost  than  before.  A  protective  tariff  which  prevented  imports  would 
immediately  stop  exports.  Under  existing  conditions,  exports  would  be  corre¬ 
spondingly  decreased  by  an  import  tariff  only  after  an  appreciable  lapse  of 
time. 


6o  ECONOMIC  ADVANTAGES  OF  COMMERCE 


A  high  export  tariff,  intended  to  prevent  exports, 
would  eventually,  like  a  protective  import  duty,  decrease 
both  exports  and  imports,  but  the  export  duty  would 
decrease  exports  first.  The  diminution  of  exports  would 
mean  a  temporary  net  outflow  of  specie  from  the  duty- 
levying  country.  Finally,  prices  in  that  country  would 
be  so  low  that  its  people  would  more  largely  supply 
themselves  with  desired  goods  and  would  buy  less  goods 
abroad.1  It  is  not  essential,  however,  that  we  should 
consider  at  length  the  effects  of  high  export  duties,  be¬ 
cause,  while  there  have  been  examples  of  such,  they  have 
been  much  less  common  than  high  import  duties,  and 
are,  at  present,  almost  unknown. 

§  2 

How  a  Protective  Tariff  Sets  Up  Unprofitable  Industries 

at  the  General  Expense 

The  fairly  direct  and  practically  immediate  effect  of  a 
protective  tariff  is  to  raise  the  prices  of  protected  goods 
by  not  more  than  the  amount  of  the  tariff.  As  we  have 
seen,  if  Canada  levies  a  50  cents  tax  per  yard  on  linen, 
to  protect  Canadian  linen  production,  an  almost  imme¬ 
diate  result  is  that  Canadian  linen  manufacturers  can 
charge  more  for  linen  than  otherwise  they  would  be  able 
to.  For  the  50  cents  tax  has,  as  a  first  consequence,2 
that  linen  from  Ireland  must  sell  for  $1.50  instead  of  $1 
a  yard.  The  tax,  therefore,  makes  it  possible  for  Cana¬ 
dian  linen  producers  to  charge  prices  (except  as  hindered 

1  With  a  combination  of  high  protection  on  all  importable  goods,  and  high 
restrictive  export  taxes,  the  prices  of  protected  goods  would  rise  because  of  their 
greater  scarcity,  but  there  would  be  no  rise  of  other  prices  due  to  inflow  of  gold 
nor  any  fall  of  prices  due  to  its  outflow. 

2  See,  however,  §§  6  and  7  of  this  chapter  (IV  of  Part  II). 


PROTECTION  AND  NATIONAL  WEALTH  61 


by  competition  with  each  other)  higher  in  about  the 
same  proportion.  Without  the  tariff  protection,  Cana¬ 
dian  linen  producers  must  sell  for  $i  a  yard  or  less,  if 
they  would  have  the  home  market.  If  all  of  them  were 
willing  to  do  this,  if  employing  manufacturers  and  their 
employees  were  willing  to  manufacture  linen  for  an 
average  return  of  $14  a  week,  or  less,  they  could  carry 
on  a  large  business  and  perhaps  almost  monopolize 
the  home  market,  even  without  a  tariff.  But  the  tariff, 
by  compelling  a  rise  in  the  imported  linen  to  $1.50,  en¬ 
ables  the  now  protected  Canadians  to  charge  (say) 
$1.43,  and  still  be  sure  of  most  of  the  Canadian  market. 
Under  Schedule  K  of  the  late  Payne- Aldrich  tariff  law,  it 
was  found  by  the  Tariff  Board  that  an  average  duty  of 
184  per  cent  levied  by  the  United  States  on  16  varieties 
of  woolen  fabrics,  resulted  in  an  average  price  for  the 
home-produced  goods  67  per  cent  higher  than  the  price 
of  like  goods  abroad.1  The  tariff  has  in  this  regard  about 
the  same  effect  as  natural  barriers  and  resulting  high 
cost  of  transportation.  Either  natural  barriers  or  the 
artificial  barriers  of  a  protective  tariff  act  tend  to  make 
more  difficult  to  get  and  more  expensive  in  one  country, 
the  products  of  another,  and,  therefore,  to  enable  the 
home  producer  to  charge  higher  prices.  The  late  Pro¬ 
fessor  William  Graham  Sumner  of  Yale  college  called 
attention  to  the  fact  that,  after  the  St.  Gothard  tunnel 
was  opened,  the  people  of  southern  Germany  petitioned 
for  higher  taxes  on  Italian  products  so  as  to  offset  the 
greater  cheapness  made  possible  by  the  tunnel.2 
-  The  protective  tariff  on  linen  makes  Canadian  manu- 


1  Report  of  the  Tariff  Board  on  Schedule  K  of  the  Tariff  Law,  1912,  Vol,  I, 
Part  I,  p.  14. 

2  Protectionism ,  New  York  (Holt),  1885,  pp.  75,  76. 


62  ECONOMIC  ADVANTAGES  OF  COMMERCE 

facture  of  the  linen  much  more  profitable  than  it  would 
else  be,  since  it  enables  the  Canadian  manufacturers  to 
charge  much  higher  prices.  It  therefore  diverts  a  cer¬ 
tain  amount  of  Canadian  labor  and  capital,  from  the 
production  of  wheat  and  from  other  lines,  into  the  pro¬ 
duction  of  linen.  As  has  already  been  suggested,  if 
Canadians  want  to  go  into  the  linen  making  industry 
and  take  what  the  industry  will  yield  them  in  open  com¬ 
petition,  they  can  do  so  without  the  tariff.  But  though 
they  can,  it  is  obvious  that  they  will  not.  For,  by  our 
familiar  assumption,  a  week’s  labor  in  Canada  will 
produce  20  bushels  of  wheat,  and  will  therefore  earn,  if 
wheat  sells  for  $1  a  bushel,  $20.  A  week’s  labor  will 
produce,  however,  but  14  yards  of  linen.  If  linen  is 
but  $1  a  yard  or  less,  the  week’s  earnings  are  but  $14. 
Without  the  tariff,  therefore,  Canadians  can  go  into 
linen  production  if  they  want  to,  and  they  may  be  able 
to  make  a  fair  living  at  it ;  but  they  will  not  want  to, 
for  the  reason  that  they  can  make  very  considerably 
more  in  another  line,  viz.  the  production  of  wheat. 
The  tariff,  by  enabling  them  to  get  $1.43  a  yard  or  more, 
though  at  the  expense  of  43  cents  a  yard  to  every  Cana¬ 
dian  purchaser  of  linen,  makes  the  business  as  profitable 
as  the  other,  or  more  so,  and  induces  some  Canadians 
to  take  it  up.  A  protective  tariff,  therefore,  causes  the 
development  of  an  industry  in  a  location  or  country 
where  it  would  not  otherwise  exist,  by  making  possible 
higher  prices  and  correspondingly  higher  returns  to 
that  industry,  and  in  that  way  alone.  Under  free  trade 
conditions,  the  location  of  various  industries  within 
different  countries  is  determined,  as  we  have  seen,  by 
the  principle  of  relative  efficiency  in  production.  The 
greatest  profitable  degree  of  geographical  specialization 


PROTECTION  AND  NATIONAL  WEALTH  63 


results.  Under  protection,  this  specialization  is  pur¬ 
posely  interfered  with,  and  what  industries  shall  be 
developed  and  maintained  in  the  protective  tariff  coun¬ 
try  depends,  in  large  part,  on  governmental  favor. 

The  general  principle  of  free  trade  follows  directly 
from  what  we  have  learned  of  the  benefits  of  international 
trade.  Geographical  specialization,  so  far  as  it  develops 
naturally  under  free  trade  conditions,  yields  a  larger 
total  product  than  local  or  national  self-sufficiency ;  and 
of  this  larger  product  the  several  trading  nations  secure 
each  a  share.  Protection  prevents  this  specialization, 
makes  impossible  the  securing  of  the  larger  total  product, 
and,  therefore,  makes  the  protected  country  in  so  far 
poorer. 

To  illustrate,  consider  again  Canada’s  50  cents  pro¬ 
tective  duty  on  linen.  Before  the  laying  of  this  duty, 
the  average  Canadian  could  produce,  in  a  week,  20 
bushels  of  wheat,  worth  $20,  and  get,  by  sale  and  pur¬ 
chase,  20  yards  of  linen  in  return.1  With  two  weeks  of 
work,  he  could  secure  20  bushels  p  us  20  yards.  After 
the  protective  tax  is  laid,  he  is  practically  compelled  to 
buy  linen  in  Canada  at  $1.43  a  yard.  He  can  still 
produce  20  bushels  of  wheat  in  a  week  and  get  his  $20, 
but  for  the  $20  he  can  get  only  14  yards  of  linen.  Two 
weeks  of  work  will  net  him  20  bushels  plus  14  yards, 
which  is  6  yards  less  2  than  if  the  tariff  did  not  exist. 

Neither  can  it  be  said  that  the  Canadians  who  are 
tempted  into  linen  manufacturing  gain  any  more  than,  or 
as  much  as,  the  wheat  producers  lose.  For  we  have  seen 
that  those  who  care  to  manufacture  linen,  employers  and 
employees,  can  have  all  the  business  they  want  and  all 


1  Minus  cost  of  transportation,  etc. 

2  Ignoring  cost  of  transportation,  etc. 


64  ECONOMIC  ADVANTAGES  OF  COMMERCE 


the  employment  they  want,  without  the  tariff,  if  they 
will  sell  the  linen  at  a  low  enough  price,  say  $i  or  less  a 
yard,  and  take  what  the  business  will  earn,  as  wages  and 
profits,  viz.  about  $14  a  week  (or  perhaps,  if  they  wish 
to  keep  linen  from  Ireland  entirely  out  and  monopolize 
the  market,  somewhat  less).  If  the  tariff  enables  them 
to  get  $1.43  a  yard  instead  of  $1,  the  best  that  can  pos¬ 
sibly  be  said  for  the  tariff  is  that  it  gives  the  linen  makers 
43  cents  for  every  43  cents  it  takes  away  from  the  wheat 
raisers  or  others  who  buy  the  linen.  If  there  is  any  way 
by  which  protection  can  give  43  cents  to  any  protected 
interest,  without  taking  at  least  43  cents  away  from  some 
person  or  persons  buying  the  taxed  article,  the  exact 
manner  in  which  protection  does  this  should  be  carefully 
set  forth  by  defenders  of  the  policy.  The  late  Professor 
Sumner  said:1  “If  Protection  is  anything  else  than 
mutual  tribute,  then  it  is  magic.” 

But  protection  does  worse  than  take  from  one  person 
in  the  protectionist  country  exactly  what  it  gives  to 
another.  In  our  illustration,  protection  does  worse  than 
take  from  the  Canadian  wheat  producers  exactly  what 
it  gives  to  the  Canadian  linen  manufacturers.  It  takes 
more  from  the  wheat  raisers  than  it  gives  to  those  who 
become  linen  producers.  The  wheat  raisers  have  to  pay 
43  cents  extra  on  every  yard  bought,  in  order  that  the 
linen  makers  may  receive  $1.43  for  what  would  other¬ 
wise  be  $1  worth  of  linen,  or  $20  a  week  in  an  occupa¬ 
tion  that  would  otherwise  yield  only  $14.  But,  by 
hypothesis,  they  could  earn  $20  anyhow,  if  they  would 
remain  in  the  business  of  wheat  production.  Therefore, 
the  people  who  do  engage  in  wheat  production  have  to 
lose  $6  on  20  yards  of  linen  in  order  that  others  may 

1  Protectionism,  p.  160. 


PROTECTION  AND  NATIONAL  WEALTH  65 


secure  $20  a  week  at  linen  manufacturing,  when  these 
others  could  secure  $20  a  week  in  wheat  production 
without  taxing  any  one  else.  It  would  seem  certain, 
then,  that  the  taxed  class  loses  more  than  the  protected 
class  gains,  if  indeed  the  latter  class  gains  anything  at 
all.  What  the  situation  amounts  to,  in  our  illustration, 
is  that  the  people  in  one  industry  are  taxed  to  encourage 
and  keep  going  another  industry  which  pays  so  ill  that 
no  one  in  the  country  would  go  into  it  if  it  were  not 
favored  by  this  policy.  This  is  what  Professor  Sumner 
had  in  mind  when  he  said  that,  by  the  whole  logic  of  the 
protectionist  system,  the  industries  to  be  aided  are  “the 
industries  which  do  not  pay,”  1  and  that  the  process,  so 
called,  of  “creating  a  new  industry”  means  simply  the 
taking  of  one  industry  and  setting  it  “as  a  parasite  to 
live  upon  another.”  2 

Various  facts  brought  out  by  the  investigations  of  the 
Tariff  Board  would  seem  to  show  that  the  establishment 
in  the  United  States  by  the  protective  tariff,  of  the  wool 
manufacturing  industry,  has  thus  been  the  establishment 
of  a  parasitic  industry  at  the  general  expense.  We  have 
already  seen  3  that  many  woolen  goods  have  been  greatly 
raised  in  price  because  of  the  exclusion,  by  protection, 
of  foreign  goods.  The  home  producers  must  receive 
these  higher  prices  in  order  that  they  may  receive,  as  a 
whole,  as  large  returns  as  they  might  otherwise  have 
secured  in  unprotected  lines ;  in  particular,  they  must 
charge  these  prices  in  order  that  the  wages  paid  to  em¬ 
ployees  may  be  high  enough  to  keep  the  latter  in  the 
wool  manufacturing  business,  and,  therefore,  that  the 
wages  may  be  as  high  as  can  be  got  in  other  employments. 

1  Protectionism,  p.  48.  s  Ibid.,  p.  45. 

*  §  2  of  this  chapter  (IV  of  Part  II). 

PART  II  —J 


66  ECONOMIC  ADVANTAGES  OF  COMMERCE 

Since  wages  in  general  in  the  United  States  are  high  and 
since  American  woolen  manufacturing  concerns  seem 
to  have  no  special  advantages  either  in  equipment  or  in 
efficiency  of  labor  over  their  foreign  rivals,1  it  follows 
that  the  cost  per  yard  of  woolen  cloth  made  in  this  coun¬ 
try  is  high.  According  to  the  estimates  of  the  Tariff 
Board,2  the  cost  of  turning  wool  into  tops  is  about  80  per 
cent  more  here  than  in  England,  of  producing  yarn  from 
the  tops  about  ioo  per  cent  more,  and  of  manufacturing 
the  yarn  into  cloth  from  66  to  170  per  cent  more,  accord¬ 
ing  to  the  kind  of  fabric  in  question.  The  effect  of  pro¬ 
tecting  the  woolen  manufacturing  industry  in  the  United 
States  has  been,  therefore,  that  the  consumers,  that  is, 
the  Americans  engaged  in  all  other  lines  of  industry, 
have  had  to  pay  much  higher  prices  for  woolen  goods 
than  would  otherwise  be  necessary,  merely  that  those 
engaged  in  the  woolen  industries  might  receive  as  high 
profits  and  wages  as  they  could  get  even  without  pro¬ 
tection  in  other  lines  of  activity.  Were  it  not  for  pro¬ 
tection  they  would  have  been  engaged  in  these  other 
lines  of  activity,  perhaps  largely  in  the  production  of 
articles  for  export,  in  transportation,  and  in  various 
commercial  pursuits.  Protection  has  drawn  them  out 
of  these  lines  at  a  very  considerable  loss  to  the  rest  of 
the  nation  and  with  no  appreciable  permanent  gain  to 
them,  if  indeed  they  have  not  eventually  shared  in  the 
general  loss.  It  would  appear  certain,  therefore,  that 
in  this  instance,  as  in  general,  protection  has  imposed  a 
cost  upon  those  in  unprotected  industries,  greater  than 
any  gain  which  it  can  be  asserted  to  have  brought  to 
those  in  the  lines  protected. 

1  Report  of  the  Tariff  Board  on  Schedule  K  of  the  Tariff  Law,  Vol.  I,  Part 
T  n  2  Ibid.,  pp.  16,  17. 


PROTECTION  AND  NATIONAL  WEALTH  67 


§  3 

The  Effect  off  Protection  on  the  Money  Prices  of  Pro¬ 
tected  Goods  and  on  the  Money  Prices  of  Unprotected 
Goods 

For  a  brief  time  after  a  protective  tariff  is  levied  on 
imports,  the  protected  country,  e.g.  Canada,  will  export 
about  as  much  as  if  trade  were  free ; 1  but  such  a  flow  of 
exports  will  not  be  continuous.  When,  as  a  result  of 
the  tariff,  Canada  diminishes  its  importations,  there  will 
be,  as  has  been  sufficiently  explained,  a  net  inflow  of 
gold.  Canadian  prices  rise  as  compared  to  foreign 
prices,  and,  if  the  amount  of  trade  and  other  factors 
remain  the  same,  rise  in  exact  proportion  to  the  increase 
of  money.  If,  for  any  reason,  prices  do  not  at  once 
become  higher  than  before  relatively  to  prices  abroad, 
the  gold  inflow  will  continue  until  they  do.  And  when, 
because  of  the  increase  of  money,  prices  rise,  this  rise 
of  prices  will  affect  protected  and  unprotected  goods 
alike.  The  increase  of  money,  with  no  corresponding 
increase  of  other  wealth,  must  mean  rise  of  prices  of 
other  wealth,  else,  with  the  greater  amount  of  money, 
the  demand  for  this  wealth  would  exceed  the  supply. 
And  as  far  as  the  increase  of  money  by  itself  is  concerned, 
it  would  affect  all  prices  in  Canada  to  the  same  extent. 
The  primary  effect,  then,  of  the  assumed  tariff,  is  to 
raise  the  price  of  linen,  in  Canada,  from  $1  to  $1.43  a 
yard,  while  not  affecting  the  price  of  wheat.  The 
secondary  effect  results  from  the  inflow  of  money.2 

1  See  §  1  (and  footnotes)  of  this  chapter  (IV  of  Part  II). 

2  Cf.  The  Purchasing  Power  of  Money,  by  Irving  Fisher  assisted  by  Harry  G. 
Brown,  New  York  (Macmillan),  ign,  p.  94.  In  justification  of  the  above  mode 
of  presentation,  it  may  be  said  that  the  drawing  of  labor  into  the  protected  in¬ 
dustry  (linen  production),  cannot  permanently  raise  the  prices  of  unprotected 


68  ECONOMIC  ADVANTAGES  OF  COMMERCE 


Suppose  money  in  Canada  increases,  because  of  the 
tariff,  by  io  per  cent.  Then  the  price  of  Canadian  wheat, 
assuming  it  to  be  produced  at  approximately  constant 
cost  per  bushel 1  regardless  of  whether  somewhat  less  or 
somewhat  more  is  produced,  would  tend  to  rise  from  $i 
to  $1.10  a  bushel;2  and  the  price  of  linen  would  rise, 
in  addition  to  the  rise  directly  occasioned  by  the  tariff, 
from  $1.43  to  $1.57  a  yard,  i.e.  in  the  same  ratio  as  the 
price  of  wheat.  How  largely  the  prices  of  unprotected 
goods  produced  in  the  United  States  have  thus  been 
made  higher  by  this  indirect  action  of  the  tariff,  it  is 
impossible  to  say,  but  that  the  prices  of  many  such  goods 
have  been  so  raised  to  some  extent,  we  may  reasonably 
conclude. 

Here  we  are  brought  again,  by  a  somewhat  different 
route,  to  the  conclusion  that  a  protective  tariff  tends 
towards  national  poverty.  For,  while  the  increased 
quantity  of  money  tends  to  raise  all  money  incomes  in 
the  same  ratio  that  it  raises  the  prices  of  goods,  and  so 
tends  to  leave  people  in  the  same  relative  position ;  yet 
the  original  and  special  rise  in  the  prices  of  the  protected 

goods,  e.g.  wheat,  by  decreasing  the  supply  of  these  goods,  unless  there  is  this 
inflow  of  specie.  For  no  one,  by  our  hypothesis,  will  leave  the  production  of 
wheat  at  $i  a  bushel  unless  he  can  get  $1.43  a  yard  for  linen,  and  no  one  would 
leave  the  production  of  wheat  at  any  higher  price  than  $1  unless  he  could  secure 
more  than  $1.43  for  the  cloth.  But  a  rise  of  wheat  above  $1  a  bushel  and  of 
cloth  above  $1.43  and  of  other  things  in  proportion,  could  not  take  place  without 
a  changed  relation  between  currency  and  goods,  without,  that  is,  in  this  case, 
an  inflow  of  money  metal.  A  continued  foreign  demand  for  the  now  less  produced 
wheat  might  cause  a  rapid  readjustment,  but  could  cause  such  readjustment 
only  through  purchases  of  the  wheat  (or  other  Canadian  goods),  and,  therefore, 
only  by  influencing  the  flow  of  gold. 

1  At  the  margin  of  cultivation. 

2  We  are  supposing  that  the  inflow  of  money  takes  place  to  such  an  extent 
as  to  have  this  result,  either  because  Canada  continues  to  export  wheat  until 
the  price  of  Canadian  wheat  has  thus  risen  10  per  cent,  or  because  Canadian 
exports  of  other  goods,  perhaps  goods  less  subject  to  the  competition  of  other 
sources  of  supply,  do  not  at  once  cease. 


PROTECTION  AND  NATIONAL  WEALTH  69 


goods  is  due  solely  to  the  greater  scarcity  of  those  goods 
and  the  greater  cost  of  their  production,  and  is  not  coun¬ 
terbalanced  by  any  increase  of  money  incomes.  There 
is  here  a  net  loss.  The  country  is  poorer  because  of 
the  tax. 

If  Canada  has  an  inconvertible  paper  money,  then 
the  protective  tariff  will  have  the  same  primary  effect  but 
a  different  secondary  effect.  It  will  raise  the  price  of 
linen  from  $1  to  $1.43  without  changing  other  prices. 
There  will  be  no  increase  of  money  due  to  a  surplus  of 
exports.  Linen  will  rise  in  price  because  of  the  greater 
cost  of  production  required  and  the  greater  scarcity  of 
it  in  relation  to  other  goods  and  to  money.  But  wheat 
and,  in  general,  goods  other  than  linen  will  not  rise  in 
price.1  Instead  of  a  general  rise  in  money  prices  bring¬ 
ing  eventual  equilibrium  by  discouraging  purchase  of 
Canadian  goods  from  abroad,  this  equilibrium  will  be 
brought  by  a  change  in  the  relative  values  of  currency,  of 
such  a  sort  that  it  requires  more  foreign  money  to  pur¬ 
chase  a  given  amount  of  exchange  on  Canada  or  to  pur¬ 
chase  the  gold  equivalent  of  a  given  amount  of  Canadian 
money.2 

As  we  have  already  seen,3  a  high  export  tariff  would 
act  in  a  way  directly  contrary  to  the  operation  of  pro¬ 
tection,  on  the  flow  of  specie  and  on  money  prices  in  the 
tax-levying  country.  While  protection  causes  an  inflow 
of  specie  and  a  rise  of  money  prices,  high  export  duties 
would  cause  an  outflow  of  specie  and  a  fall  of  money 
prices.  But  in  its  effect  on  national  prosperity,  a  high 
export  tariff  would  not  require  to  be  thus  sharply  dis- 


1  Assuming  production  under  constant  cost. 

3  See  Part  I,  Ch.  VI,  §§  6,  7,  8,  9. 

3  §  1  of  this  chapter  (IV  of  Part  II). 


70  ECONOMIC  ADVANTAGES  OF  COMMERCE 


tinguished  from  protection.  It  would,  as  protection 
does,  turn  industry  out  of  its  natural  channels  into  less 
productive  channels.  The  difference  is  that,  while  the 
method  of  protection  involves  a  selection  of  industries 
to  be  established  at  the  general  expense,  a  high  export 
tariff  would  secure  the  establishment  of  new  and  less 
profitable  industries,  indirectly,  by  preventing  produc¬ 
tion  for  export  in  the  industries  most  profitable.  Export 
restrictions  have  been  applied,  in  the  past,  along  with 
restrictions  on  imports,  to  divert  labor  from  a  relatively 
large  production  of  raw  materials,  into  the  manufacture 
of  those  materials.  England’s  statutory  law,  from  the 
time  of  Edward  III  through  many  generations,  forbade 
the  export  of  sheep  or  raw  wool,  while  aiming  to  prevent 
importation  of  woolen  cloth.1  The  desire  was  to  stimu¬ 
late  the  making  of  woolen  cloth  in  England. 

It  is  worth  pointing  out  that  a  high  tariff  levied  by 
a  country  upon  its  exports,  affects  that  country  as  to 
money  prices  and  general  prosperity,  in  the  same  way  as 
high  import  duties  levied  on  the  same  articles  of  its 
production  by  all  the  countries  with  which  it  trades. 
A  high  export  duty  levied  by  Canada  on  wheat,  would 
have  the  same  effect  as  high  import  duties  on  this  wheat 
levied  by  other  countries;  it  is  indeed  equivalent  to  a 
combination  of  all  possible  consuming  countries  to  levy 
such  an  import  duty  against  Canada.  Similarly,  a 
high  import  tax,  i.e.  a  “ protective  tariff,”  is  equivalent 
to  high  export  duties  levied  by  not  one  only  but  all 
other  countries  from  which  the  taxed  goods  might  come. 

1  Levi,  The  History  of  British  Commerce ,  second  edition,  London  (John  Mur¬ 
ray),  1880,  pp.  22,  23,  footnote;  also  Day,  A  History  of  Commerce,  New  York 
(Longmans,  Green  &  Co.),  1907,  p.  225. 


PROTECTION  AND  NATIONAL  WEALTH  71 


§4 


Protection  to  Industries  in  which 

is  Advantageous 


Production 


When  a  protected  industry  is  one  of  those  in  which 
large  scale  production  is  advantageous,  there  are,  as 
regards  the  carrying  on  of  the  industry  in  the  protection¬ 
ist  country,  two  possibilities.  The  first  possibility  is 
that  the  encouragement  and  further  extension  of  home 
production  in  that  industry  will  mean  home  production 
on  a  larger  scale  than  formerly,  i.e.  few,  if  any,  more 
plants,  but  larger  product  turned  out  by  each  plant. 
If  the  tariff  has  this  effect,  it  means  cheaper  home  pro¬ 
duction  than  before,  and,  if  the  improvement  is  great 
enough,  cheaper  production  at  home  than  abroad.1 

The  second  possibility  is  that  the  size  of  establishment 
having  the  greatest  efficiency  is,  on  the  average,  already 

1  There  is  another  conceivable  case,  which  may  properly  be  mentioned  at  this 
point,  where  protection  might  really  increase  national  wealth.  Suppose  a  coun¬ 
try  to  be  carrying  on  only  one  or  a  few  industries  and  to  be  the  only  country 
where  these  industries  are  carried  on.  Those  engaged  in  them,  however,  we 
shall  assume  to  be  subject  to  competition  from  others  in  their  own  country.  In 
such  a  case,  a  protective  tariff  which  should  divert  labor  into  a  line  unprofitable 
without  such  aid,  might  so  restrict  the  supply  of  the  goods  of  which  the  country 
had  a  monopoly,  as  to  raise  very  greatly  the  prices  of  those  goods  abroad  and  so 
increase  the  country’s  prosperity  at  the  expense  of  foreigners.  But  unless  the 
country  had  a  monopoly  of  the  industries  from  which  labor  is  turned,  it  could 
not  appreciably  raise  the  prices  of  the  goods  by  so  doing,  for  the  competition  of 
other  sources  of  supply  would  keep  the  prices  down.  Furthermore,  unless  most 
of  the  industries  in  which  the  protectionist  country  is  engaged  are  industries 
in  which  it  has  a  monopoly,  the  establishment  of  new  industries  by  protection 
will  draw  from  other  lines  as  well  as  from  the  monopoly  lines,  and  will  therefore 
not  so  much  decrease  the  supply  of  goods  in  the  monopoly  lines  and  not  so  much 
raise  their  prices.  If  a  country  has  a  monopoly  of  only  one  or  a  few  lines  and 
those  not  important,  and  the  situation  is  almost  certain  to  be  no  more  favorable 
than  this  to  the  protectionist  country,  then  the  effect  of  protection  will  so  little 
decrease  the  supplies  of  the  monopolized  goods  as  to  have  slight  appreciable 
effect  on  their  prices.  In  short,  as  things  are  in  the  actual  civilized  world,  the 
circumstances  under  which  protection  can  be  reasonably  expected  to  increase 
national  wealth  probably  nowhere  exist. 


72  ECONOMIC  ADVANTAGES  OF  COMMERCE 

reached  before  protection  is  granted,  or,  if  it  is  not,  that 
lack  of  a  tariff  is  not  the  difficulty.  On  this  assumption, 
the  imposition  of  a  tariff  would  very  probably  result  in 
an  increase  of  the  number  of  plants  engaged  in  the  in¬ 
dustry  within  the  protectionist  country,  but  not  in  any 
saving  through  more  efficient  plants.  By  hypothesis, 
increased  size  of  plants,  beyond  that  already  reached, 
is  no  longer  a  saving,  or  will  not  be  brought  about  by 
protection.  If  the  industry  was  being  carried  on  within 
the  country  to  any  appreciable  extent,  before  the  adop¬ 
tion  of  a  protective  policy,  a  change  in  the  average  size 
of  establishments,  as  a  result  of  that  policy,  cannot  be 
regarded  as  assured.  In  any  case,  the  development  of 
efficiency  resulting  from  larger  scale  production  must, 
if  it  is  to  yield  any  net  gain  to  the  nation  in  question,  be 
so  great  that  the  desired  goods  can  be  secured  at  home 
more  cheaply  than  they  could  otherwise  be  imported. 
Large  scale  production  in  other  countries  and  purchase 
of  the  goods  from  them  may,  in  practice,  better  secure 
the  national  welfare. 

§5 

Protection  to  Industries  of  Increasing  Cost 

When  commodities  for  home  consumption  must  be 
produced  within  a  country  under  conditions  of  sharply 
increasing  cost  and,  because  of  limited  resources,  under 
disadvantageous  conditions  at  the  margin  of  production, 
the  opportunity  to  import  these  commodities  from  abroad 
is,  perhaps,  particularly  to  be  desired.  The  policy  of 
protection  to  the  home  production  of  such  goods  causes, 
in  the  protectionist  country,  production  at  an  increas¬ 
ingly  greater  cost  according  as  the  protection  succeeds 
in  its  object.  Thus,  Germany’s  policy  of  protection 


PROTECTION  AND  NATIONAL  WEALTH  73 


to  agriculture,  favored  by  the  owners  of  agricultural 
land,  undoubtedly  means  the  production  of  food  at  a 
progressively  higher  cost  in  proportion  as  the  protection 
is  effective.  A  high  tariff  protective  to  English  agricult¬ 
ure  would  probably  raise  the  cost  of  food  so  high  as  to 
starve  to  death  millions  of  the  English  people.  An  anal¬ 
ogous  consequence  follows  from  protection  to  manu¬ 
factures  when  the  tariff  wall  safeguards  the  more  in¬ 
efficient  plants  against  loss  from  foreign  competition, 
compelling  consumers  to  pay  prices  for  the  goods  desired, 
which  will  remunerate  the  inefficient  as  well  as  the  effi¬ 
cient  home  producers.  Protection,  then,  forces  con¬ 
sumers  to  get  many  of  the  goods  they  require,  at  greater 
cost,  either  because  the  production  cost  at  home  is 
uniformly  greater,  or  because  protection  compels  the 
use  of  the  poorer  soils,  the  poorer  mines,  the  poorer  sites, 
or  because  it  compels  the  giving  of  patronage  to  estab¬ 
lishments  which  are  relatively  inefficient. 

But  may  it  not  be  desirable,  in  case  a  country  has  a 
large  export  trade  in  goods  produced  under  conditions 
of  increasing  cost,  e.g.  wheat,  to  establish  manufactures 
by  protection  in  order  to  draw  capital  and  labor  away 
from  the  poorer  or  marginal  lands  ?  Even  here  the  pro¬ 
tectionist  policy  involves  a  loss,  though  perhaps  not  so 
great  a  loss.  It  is  only  if  and  because  even  the  poorest 
lands  in  use,  following  the  terms  of  our  illustration, 
yield  20  bushels  or  $20  a  week  in  Canada  compared  with 
a  possible  14  yards  or  $14  in  the  unprotected  linen  in¬ 
dustry,  that  protection  is  required  to  establish  the  latter.1 
If  it  were  more  profitable  than  agriculture,  even  than 
agriculture  on  the  poorer  lands,  it  would  be  established 
without  protection.  If  it  requires  protection,  it  is  a  less 

1  Cf.  what  is  said  regarding  protection  of  this  sort,  in  Ch.  V  (of  Part  II),  §  5. 


74  ECONOMIC  ADVANTAGES  OF  COMMERCE 


profitable  business  from  the  standpoint  of  the  whole 
Canadian  people,  than  agriculture  on  the  best  available 
land  and,  therefore,  than  agriculture  on  the  poorest 
land  actually  used. 

§6 

Effect  of  a  Country s  Protective  Tariff  System  on  the  Cost 

to  it  of  Unprotected  Goods  Got  from  Other  Countries 

A  protective  policy,  however,  may  conceivably  give 
to  the  nation  which  enforces  it,  indirect  advantages 
compensating  in  part  or  in  whole  for  the  losses  incurred. 
Though  the  conditions  under  which  such  advantages 
would  be  at  all  comparable  with  the  losses,  could  seldom 
if  ever  occur  in  practice,  it  is  perhaps  worth  while  to  show 
what  these  conditions  are.  If  Canada  levies  a  high 
tariff  on  linen  from  Ireland,  and,  as  a  result,  following  the 
flow  of  gold  to  Canada,  Canadian  prices  rise  and  Irish 
prices  fall,  then  other  goods,  e.g.  laces,  silks,  etc.,  may 
be  produced  in  Ireland  more  cheaply  than  before.  In 
practice,  the  effect  would  be  more  largely  a  rise  of  Cana¬ 
dian  than  a  fall  of  Irish  prices ;  for  the  fall  of  prices  due 
to  outflow  of  gold  must  eventually  be  distributed  over 
many  countries  and  would  be  slight  in  each,  while  the 
rise  of  prices  would  be  felt  in  Canada  alone.  But,  at 
any  rate,  since  Canadians  receive  more  for  their  wheat, 
the  silk,  etc.,  from  Ireland  (or  other  countries)  can  be 
better  afforded  than  formerly.1  If,  therefore,  the  result 
of  protection  is  that  Canada  receives  more  for  her  ex¬ 
ports,  and,  while  shutting  out  linen,  gets  certain  other 

1  This  point  is  stated  in  relation  to  the  protective  policy  by  Taussig,  Prin¬ 
ciples  of  Economics,  New  York  (Macmillan),  ign,  Vol.  I,  p.  525.  The  prin¬ 
ciple  is  exactly  the  same  as  was  shown  to  apply  to  import  revenue  duties  by  Mill, 
Principles  of  Political  Economy,  Book  V,  Ch.  IV,  §  6,  and  by  Bastable,  The 
Theory  of  International  Trade,  fourth  edition,  London  (Macmillan),  1903,  p. 
1 18.  Cf.  also  supra,  Ch.  Ill  (of  Part  II),  §  3. 


PROTECTION  AND  NATIONAL  WEALTH  75 


foreign  goods  for  a  less  price  than  formerly,  so  getting, 
for  example,  more  silk  than  previously  for  a  given  amount 
of  wheat,  it  is  not  entirely  certain  that  Canada  has  lost 
greatly  by  her  tariff  policy. 

Needless  to  say,  this  is  not  an  argument  for  protection 
that  would  win  it  many  votes.  For  a  political  campaign 
speaker  to  tell  the  voters  of  Canada  that  a  proposed 
tariff  will  hinder  a  profitable  trade  and  prevent  their 
getting  linen  cheaply  from  Ireland,  but  that  in  conse¬ 
quence  they  may  be  able  to  buy  silk  somewhat  more 
cheaply  than  before  in  terms  of  wheat,  would  not  be 
likely  to  arouse  any  great  enthusiasm.  A  more  prob¬ 
able  result  would  be  a  demand  from  silk  manufacturers 
in  Canada,  or  from  would-be  silk  manufacturers,  that 
they  also  receive  protection.  The  rising  money  cost  of 
production  in  Canada,  and  the  tendency  to  falling  cost 
in  Ireland,  would  imperil  the  Canadians’  home  market. 
Especially  would  silk  manufacturers  in  Canada  be  in¬ 
jured,  if  they  had  to  use  machinery  or  raw  material 
directly  raised  in  price  by  the  tariff  system.  But  if 
the  silk  manufacturing  and  other  lines  of  production 
should  also  be  protected,  Canada  would  no  longer  gain 
from  the  protection  of  linen  the  indirect  benefit  sug¬ 
gested.  The  higher  money  incomes  received  in  Canada 
are  no  advantage  if  they  must  be  spent  in  Canada ,  where 
prices,  counting  prices  of  protected  goods,  have  been 
raised  even  more  by  the  tariff,  than  have  money  incomes. 
A  consistently  protectionist  country  can  hope  to  realize 
this  indirect  gain  from  protection,  only  on  goods  not 
producible  at  home  and,  therefore,  not  protected.  And 
the  direct  loss  in  higher  prices  of  protected  goods  may  be 
very  great  indeed.  As  we  have  already  seen,1  many  kinds 

1  §  2  of  this  chapter  (IV  of  Part  II). 


76  ECONOMIC  ADVANTAGES  OF  COMMERCE 

of  woolen  goods  have  been  costing  Americans  some  60 
to  70  per  cent  more  because  of  the  tariff. 

In  the  actual  commercial  world,  Canada  is  the  less 
likely  to  realize  much,  at  Ireland’s  expense  (or  at  the 
expense  of  other  countries),  through  this  indirect  action 
of  the  tariff,  because  Ireland  (or  any  other  country)  has 
the  alternative  of  trading  elsewhere,  and  is  not  obliged 
to  offer  reluctant  Canada  bargains,  in  order  to  force  a 
trade,  except  as  Canada  may  have  a  substantial  mo¬ 
nopoly  of  the  production  of  certain  goods.1  Canadians 
can  get  little,  if  any,  more  for  wheat  or  other  exported 
goods  than  before,  else  Ireland  will  refuse  to  buy.  And 
rather  than  accept  a  low  price  for  silk  and  other  goods, 
Ireland  may  sell  them  elsewhere  than  in  Canada.  It  is 
the  more  unlikely,  therefore,  that  Canada  will  gain,  thus 
indirectly,  as  much  as  she  loses  directly,  through  the  tariff. 

In  so  far  as  a  protective  policy  results  in  a  larger  quan¬ 
tity  of  money  and  higher  money  prices  in  the  protec¬ 
tionist  country,  it  is  likely  to  lead  to  a  demand  for  a 
progressively  higher  and  higher  tariff.  Assume,  as 
before,  a  50  cents  duty  per  yard  levied  by  Canada  on 
linen.  This  at  first  makes  linen  cloth  from  Ireland 
$1.50,  while  Canadian  cloth  can  sell  for  $1.43  and  still 
yield  as  large  a  money  return  as  the  production  of  Cana¬ 
dian  wheat.  This  enables  a  Canadian  linen  manufac¬ 
turer  to  undersell  his  rival  of  Ireland  by  7  cents  a  yard. 
But  the  flow  of  gold  into  Canada,  resulting  from  the 
tariff,  will  raise,  among  other  prices,  the  money  cost  of 

1  Even  without  a  monopoly,  if  Canada  supplied  so  much  of  the  wheat  used  in 
Ireland  and  other  countries  that  for  them  to  substitute  wheat  from  other  sources 
would  lower  the  margin  of  cultivation  and  raise  wheat  prices,  Canada  could  con¬ 
tinue  to  sell  some  wheat  at  slightly  higher  prices  than  before  the  tariff  was  laid. 
There  would  remain,  however,  the  probably  much  more  important  effect  of  the 
tariff,  for  Canada,  in  the  direct  loss  caused. 


PROTECTION  AND  NATIONAL  WEALTH  77 


producing  linen.  In  Ireland,  on  the  contrary,  the  ten¬ 
dency  will  be  towards  a  lower  cost.  Soon,  therefore,  the 
Canadian  manufacturer  may  find  that  $1.43  is  not  a 
high  enough  price,  while  the  linen  manufacturer  of  Ireland, 
even  with  the  tax,  may  sell  for  less  than  $1.50.  Unless 
the  tariff  is  further  increased,  some  linen  will  soon  be 
secured  from  Ireland ;  there  will  no  longer  be  a  net  flow 
of  gold  into  Canada ;  and  Canadian  prices  will  no  longer 
rise  as  compared  with  Irish  prices.  Or,  as  we  have  seen, 
the  same  result  is  reached  by  Canadian  purchase  of  other 
Irish  goods.  Suppose,  however,  that  the  Canadian  tariff 
is  progressively  raised  so  as  to  maintain  the  7  cent  mar¬ 
gin,  and  is  raised  on  other  Irish  goods  as  well,  and  suppose 
that  Ireland’s  demand  for  Canadian  goods  is  not  checked 
until  money  in  Canada  is  -9-  of  its  former  amount  and 
in  Ireland  slightly  less  than  before.  Then,  assuming 
conditions  of  approximately  constant  cost,  Canadian 
wheat  will  sell  for  about  $1.10  a  bushel  and  Canadian 
linen  for  $1.57,  while  linen  made  in  Ireland  will  sell, 
not  counting  the  tariff,  for  slightly  less  than  $1  (not 
much  less,  since  any  considerable  fall  of  prices  in  Ireland 
would  cause  an  inflow  of  specie  from  Germany,  France, 
and  elsewhere,  so  distributing  over  many  countries  the 
effect  of  the  outflow  of  money  to  Canada).  To  give 
Canadian  producers  a  7  cents  margin,  the  tariff  will  now 
have  to  be  so  high  that  linen  made  in  Ireland  can  sell, 
in  Canada,  for  not  less  than  $1.64.  Since  this  linen 
sells,  without  the  tariff,  for  $1  or  less,  the  tariff  will  have 
to  be  $0.64  a  yard  1  instead  of  the  original  $0.50.  Even  a 
tariff  to  “ equalize  the  cost  of  production”  would  need, 
after  this  change  in  relative  amounts  of  money,  to  be 
$0.57  instead  of  $0.43. 

1  We  are  here  neglecting  cost  of  transportation. 


78  ECONOMIC  ADVANTAGES  OF  COMMERCE 


But  it  must  not  be  supposed  that  continuous  extension 
and  increase  of  its  tariff  wall  can  raise  prices  in  a  country 
without  limit.  Even  if,  as  prices  in  Canada  rise  and  in 
Ireland,  or  elsewhere,  fall,  protection  is  given  to  each 
article  subject  to  foreign  competition,  which  can  be  made 
in  Canada,  and  even  if  this  protection  is  progressively 
raised  so  as  to  prevent  any  purchase  abroad  by  Cana¬ 
dians  as  their  money  incomes  increase,  —  in  short,  even 
if  all  importation  of  goods  is  effectively  prohibited,  the 
rise  of  prices  in  Canada  will  nevertheless  eventually 
reach  a  limit.  For,  sooner  or  later,  Canadian  prices  will 
get  so  high  that  no  goods  whatever  will  be  purchased  in 
Canada  by  people  in  foreign  countries. 

All  these  conclusions  are  the  same,  except  as  to  nominal 
prices,  if  we  suppose  Canada’s  currency  system  unrelated 
to  those  of  other  countries.  A  high  tariff  would  not 
then  raise  Canadian  money  prices,  but  it  would  change 
the  relative  value  of  Canadian  and  other  monetary  stand¬ 
ards  so  as  to  make  purchase  of  Canadian  goods  more 
expensive  to  other  countries  in  terms  of  their  own  money. 
This  fact  has  been  frequently  pointed  out  in  preceding 
pages.  Here  it  is  to  be  emphasized  that  it  means  cheaper 
purchase  of  foreign  goods  in  terms  of  Canadian  goods. 
A  smaller  amount  of  Canadian  money  than  before  will 
buy  drafts  on  foreign  countries  for  more  foreign  money 
and,  therefore,  goods  than  before,  or  will  buy  the  gold 
equivalent  of  more  foreign  money  and  goods  than  before. 
Hence,  Canadians  are  tempted,  unless  prevented  by  a 
tariff,  to  buy  foreign  goods  which  they  did  not  previously 
buy  and  even,  unless  the  tariff  protection  is  increased, 
to  buy  goods  on  which  the  protection  seemed,  at  first, 
adequate  (though  not  excessive). 


PROTECTION  AND  NATIONAL  WEALTH  79 


§  7 

A  Tariff  “Equal  to  the  Difference  in  Cost  of  Production 

at  Home  and  Abroad ,  together  with  a  Reasonable  Profit” 

In  view  of  these  facts,  together  with  the  fact  that  the 
same  kinds  of  goods  are  produced  simultaneously  at 
different  costs,  the  proposition,  prominently  put  forth 
in  recent  politics,  to  establish  a  tariff  which  shall  “  equal 
the  difference  in  the  cost  of  production  at  home  and 
abroad,  together  with  a  reasonable  profit,” 1  is  chimeri¬ 
cal.  There  is  no  fixed  difference,  independent  of  the  tariff, 
in  the  home  and  foreign  costs  of  production.  For  the 
difference  in  these  costs  is  dependent,  to  some  degree, 
on  the  relative  levels  of  prices  at  home  and  abroad, 
which  are  affected  by  the  flow  of  gold,  which  is,  in  turn, 
at  least  in  some  degree  affected  by  the  tariff.  The  tariff 
itself,  that  is,  helps  to  cause  the  very  difference  in  cost 
of  production  which  is  set  forth  as  a  justification  for  it. 
As  we  have  seen  in  our  illustration,  a  tax  of  43  to  50  cents 
per  yard  may  be,  at  the  start,  the  amount  necessary  to 
equalize  cost  of  production  in  the  protectionist  and  other 
countries,  and  yield  a  “reasonable”  profit;  yet  later,  if 
a  protective  tariff  policy  has  been  followed,  a  higher  tax 
than  43  cents  may  seem  equally  necessary  to  equalize 
conditions,  and  this  just  because  the  tariff  itself  has 
widened  the  cost  difference.  In  addition,  the  cost  of 
production  may  be  directly  increased  by  tariff  duties  on 
the  machinery  and  raw  materials  of  industry. 

Again,  “cost  of  production,”  if  not  further  defined, 
may  be  taken  to  mean  marginal  cost,  average  cost,  or 
cost  under  the  most  favorable  circumstances.  Is  a  tariff 

1  Republican  party  platform  of  1908,  Republican  Campaign  Text-Book,  1908, 
p.  462. 


80  ECONOMIC  ADVANTAGES  OF  COMMERCE 

which  equals  the  difference  in  cost  of  production  at  home 
and  abroad,  to  be  high  enough  adequately  to  protect 
the  marginal  producer,  or  the  average  producer,  or  only 
the  producer  best  situated  ?  In  manufacturing,  is  it 
to  protect  the  struggling  factory  hardly  able  to  maintain 
itself,  or  only  the  most  efficient  ?  If  protection  is  to  be 
given  to  the  producer  under  greatest  difficulties  and  to 
the  most  inefficient  producer,  the  burden  on  consumers 
may  be  very  great.  Furthermore,  inefficiency  is  in  some 
degree  encouraged,  instead  of  being  weeded  out.  The 
recent  Tariff  Board  found  in  the  cotton  manufacturing 
industry  of  the  United  States  not  only  modern  estab¬ 
lishments,  but  also  some  of  low  efficiency  and  considerable 
antiquity.1  Some  6o-year  old  spinning  and  weaving 
machinery  was  still  in  use.  A  system  which  protects 
producers  the  more  highly  the  less  efficient  they  are, 
though  promulgated  as  a  “scientific”  solution  of  the 
tariff  problem,  would  seem,  in  view  of  these  considera¬ 
tions,  very  far  from  being  such  a  solution.  If,  on  the 
other  hand,  the  protection  is  intended  only  to  equalize 
conditions  for  the  average  or  best  producers,  as  opposed 
to  foreign  competitors,  there  is  still  a  loss  to  consumers, 
and  there  is  also  the  objection,  from  the  protectionist 
point  of  view,  that  such  a  policy  would  leave  without 

adequate  protection  the  very  producers  most  needing 
help. 

§  8 

Relative  Advantages  in  the  World's  Commerce  of  Countries 
having  High  and  Countries  having  Low  or  No  Tarijfs 

Before  closing  our  discussion  of  protective  tariffs  in 
relation  to  national  prosperity,  there  is  one  general  truth 

1  Report  of  the  Tariff  Board  on  Schedule  I  of  the  Tariff  Law,  Vol.  2,  p.  416. 


PROTECTION  AND  NATIONAL  WEALTH  81 


to  which  we  may  properly  give  special  emphasis.  This 
truth  is  that,  among  a  number  of  trading  countries,  those 
with  low  or  with  no  tariff  restrictions  have  the  least  to 
lose.1  If,  for  example,  Great  Britain  alone  adheres  to 
the  principles  of  free  trade,  while  all  other  nations  main¬ 
tain  high  import  duties  (or  high  export  duties,  or  both), 
then  Great  Britain’s  position  in  trade  is  relatively  the 
best.  In  the  first  place,  purchasers  in  all  other  coun¬ 
tries  will  buy  of  Great  Britain  rather  than  of  countries 
where  the  large  quantity  of  money  due  to  protection  (or 
where  high  export  duties,  if  such  were  common)  makes 
prices  of  goods  exported  by  them  high;  and  this  very 
turning  of  the  demand  to  Great  Britain  will  enable 
British  producers  to  get,  for  what  goods  they  are  able, 
despite  foreign  protective  tariffs,  to  export,  higher  prices 
than  if  their  rivals  in  selling  each  special  kind  of  goods 
in  a  given  market,  were  similarly  untrammelled.  In 
the  second  place,  sellers  of  goods  produced  in  all  other 
countries,  being  unable  to  sell  so  easily  and  profitably 
to  countries  maintaining  protective  tariffs  against  them 
(or  to  countries,  if  there  were  any  such,  whose  export 
tariffs  make  their  home  prices  low),  will  be  the  more 
anxious  to  sell  all  they  can  in  Great  Britain ;  and  they 
will  make  even  lower  prices  in  selling  to  Great  Britain 
than  otherwise  they  would,  because  it  is  so  difficult  to 
secure  a  market  and  to  sell  at  a  profit,  anywhere  else. 

Protectionist  writers  have  sometimes  hinted  that  free 
trade,  or  tariff  for  revenue  only,  might  be  very  good  if 
all  nations  practised  it,  but  that  so  long  as  other  coun¬ 
tries  practise  protection,  we  must  do  so  in  self-defence. 
The  truth  is  that  the  best  possible  way  for  a  nation  to 
adapt  itself  to  the  conditions  caused  by  the  bad  policy 

1  Cf.  Bastable,  The  Theory  of  International  Trade,  p.  122. 


PART  II  —  G 


S2  ECONOMIC  ADVANTAGES  OF  COMMERCE 


(e.g.  protective  tariffs)  of  the  others,  is  to  avoid  imitating 
that  bad  policy.  Then  it  has  an  advantage  over  these 
others  and  gains  trade  and  profit  which  they  cannot.1 

It  does  not  follow  that  Great  Britain  is  better  off  be¬ 
cause  other  nations  have  high  duties.  So  far  as  other 
countries  become  self-sufficient  by  means  of  their  tariffs, 
Great  Britain  also  may  be  forced  to  be  more  self-sufficient 
than  would  otherwise  be  necessary.  But  so  far  as  some 
trade  still  persists,  despite  these  interferences,  Great 
Britain  has  an  advantage  in  getting  it  and  in  gaining 
from  it,  over  all  the  others.  Each  country’s  tariff  lessens 
Great  Britain’s  trade  with  that  country  and  so  tends  to 
decrease  the  wealth  of  both  Great  Britain  and  the  country 
levying  the  tariff.  But  each  country’s  tariff  hurts  that 
country  as  a  competitor  of  Great  Britain  in  trade  with 
third  and  fourth  countries,  and  so  gives  Great  Britain 
an  advantage  over  it. 

Largely,  we  may  reasonably  suppose,  through  the 
operation  of  these  principles,  the  foreign  commerce  of 
the  United  Kingdom  long  since  reached  a  volume  which 
that  of  none  of  her  protectionist  rivals  has  yet  been  able 
to  attain.  Not  only  do  the  people  of  the  British  Isles 
trade  extensively  with  the  Engh’sh-speaking  peoples  of 
their  own  colonies  and  with  the  United  States,  but  their 
commerce  is  the  greatest  with,  for  example,  most  of  the 
South  American  republics,2  as  well  as  with  many  other 
countries.  Their  ships  plough  the  remotest  seas  and  carry 
the  products  of  English  mines  and  factories  to  parts  of 
the  earth  almost  unknown  to  American  exporters.  Like¬ 
wise,  from  all  parts  of  the  world  come  the  raw  materials, 

1  Cf.  Sumner,  Protectionism,  New  York  (Holt),  1885,  pp.  138,  139. 

2  See  comparative  statistics  in  any  of  the  recent  annual  reports  on  Commercial 
Relations  of  the  United  States. 


PROTECTION  AND  NATIONAL  WEALTH  83 


the  food  supplies  and  other  goods,  which  the  British 
people  require  and  which  they  can  buy  more  cheaply 
abroad  than  they  can  produce  at  home.  Raw  cotton 
they  get  from  the  United  States,  from  Egypt,  from 
India,  to  be  reshipped  to  South  America  and  elsewhere 
as  cotton  fabrics,  or  to  be  made  up  into  wearing  ap¬ 
parel  for  themselves.  Wheat  they  secure  from  the 
United  States,  Canada,  Argentina,  and  other  countries, 
and  they  secure  it,  we  must  conclude,  all  the  more 
cheaply  because  some  of  the  European  nations  restrict 
its  importation  by  means  of  protective  duties.  Wool  is 
available  particularly  in  South  America  and  in  Australia. 
In  short,  the  whole  world  is  a  British  market  so  far  as 
the  British  people  can  make  it  so,  and  from  countries 
near  and  far  they  draw  the  riches  which  other  nations, 
by  foolish  tariff  restrictions,  shut  away. 

§  9 

Summary 

The  general  conclusion  of  this  chapter  is  that  a  pro¬ 
tective  tariff  reduces,  and  may  reduce  considerably, 
the  total  wealth  of  the  country  which  adopts  it.  By  as 
much  as  it  hinders  imports,  by  so  much  it  must,  in  the 
long  run,  interfere  with  the  development  of  an  export 
trade.  It  diverts  the  productive  force  of  a  country  from 
lines  in  which  it  is  relatively  effective  to  lines  in  which  its 
effectiveness  is  less.  Even  if  those  who  are  protected 
gain  some  benefit  from  the  policy,  they  gain  less  than 
others  in  the  country  lose.  Protection  tends  to  raise  all 
money  prices,  including  money  incomes,  in  the  protected 
country.  But  there  is  a  special  rise  of  price  of  protected 
goods,  not  balanced  by  any  rise  of  money  incomes. 


84  ECONOMIC  ADVANTAGES  OF  COMMERCE 

Therefore,  prices  of  goods  rise,  on  the  average,  more  than 
money  incomes,  and  the  general  prosperity  is  reduced. 
It  is  conceivable,  but  improbable,  that  protection  of 
some  industries  may  result  in  larger  establishments 
within  the  protectionist  country  and  a  gain  in  efficiency 
enough  to  make  home  production  as  cheap  as  foreign. 
When  an  industry  of  increasing  expense  (diminishing 
returns)  is  protected,  the  injurious  effects  on  national 
prosperity  are  the  greater,  the  more  the  tariff  extends 
the  industry.  Protection  may  give  to  a  country  indirect 
advantages  in  the  form  of  better  rates  of  interchange 
on  other,  unprotected  goods,  but  this  gain  is  not  likely 
to  be  great,  since  other  countries  have  the  option  of 
trading  elsewhere  than  with  the  protectionist  country. 
If  such  a  gain  were  likely  to  be  realized,  there  would 
probably  be  a  demand,  in  the  protectionist  country, 
for  the  taxation  of  imports  of  these  other  goods  in  so 
far  as  they  could  be  produced  at  home,  and  so  a  partial 
prevention  of  the  gain. 

If  protection  is  applied  moderately  but  upon  many 
goods,  so  that  the  scale  of  prices  in  the  protectionist 
country  rises  compared  with  others,  even  some  of  the 
protected  goods  may  come  to  be  imported  to  some  extent 
from  countries  whose  prices  have  not  thus  been  artifi¬ 
cially  raised.  If  so,  there  is  likely  to  be  a  demand  for 
further  protection.  The  proposition  to  levy  a  tariff 
which  shall  be  equal  to  the  difference  in  cost  of  produc¬ 
tion  in  the  protected  country  and  abroad,  overlooks  the 
fact  that  this  difference  in  cost  is,  to  some  extent,  a 
consequence  of  high  protection.  It  overlooks,  also,  the 
fact  that  cost  is  not  the  same  in  all  establishments  or  on  all 
sites,  within  a  single  country. 

Despite  the  frequent  claim  of  some  protectionists  that 


PROTECTION  AND  NATIONAL  WEALTH  85 


any  one  country  must  adopt  a  protective  tariff  system 
because  others  do,  the  truth  is  that  a  country  which, 
among  others  having  high  import  duties  (or  export  duties 
or  both),  maintains  free  trade  or  only  low  tariffs,  has  an 
advantage,  because  of  this  policy,  over  all  the  others. 


CHAPTER  V 


The  Effects  of  Protection  on  the  Distribution  of 
National  Wealth  among  Economic  Classes  and 
Territorial  Sections 


§  i 

Effect  of  Protection  on  the  Rate  of  Interest  and  Therefore 

on  Wages 

In  discussing  the  effects  of  a  protective  tariff  on  the  dis¬ 
tribution  of  wealth  and  income  among  economic  classes, 
it  is  important  that  we  have  in  mind  some  idea  of  the 
laws  according  to  which  wealth  and  income  are  divided. 
The  benefits,  or  the  wealth  and  income,  resulting  from 
production  are  said  to  be  divided  among  capitalists, 
laborers,  and  land  owners.  Capitalists  receive  interest ; 
laborers  receive  wages ;  land  owners  receive  rent. 

Interest  arises,  in  large  part,  from  the  surplus  pro¬ 
ductivity  of  indirect  or  roundabout  production,  over 
direct.1  Men  can  produce  consumers’  wealth  and  in¬ 
come  by  applying  labor  with  the  aid  of  existing  machin¬ 
ery,  or  they  can  devote  time  to  increasing  the  amount 
of  machinery  in  order  to  get,  later,  larger  results.  The 
second  method  is  more  indirect  or  roundabout.  It 

1  It  is  not  claimed  that  the  theory  of  interest  as  here  briefly  stated  is  com¬ 
plete,  or  anything  but  a  working  theory  sufficient,  perhaps,  for  the  requirements 
of  this  chapter.  The  subject  of  interest  is  so  interwoven  with  other  economics, 
that  it  cannot  be  satisfactorily  treated  in  a  few  paragraphs.  The  critical  reader 
is  referred  to  the  writer’s  article  in  the  Quarterly  Journal  of  Economics,  August, 
I9I3»  entitled  The  Marginal  Productivity  versus  the  Impatience  Theory  of 
Interest,  and  to  a  later  article  in  The  American  Economic  Review,  June,  1914, 
on  “The  Discount  versus  the  Cost  of  Production  Theory  of  Capital  Valuation.” 

86 


PROTECTION  AND  DISTRIBUTION 


87 


yields,  in  general,1  a  surplus  product  over  what  can  be 
secured  by  the  more  direct  method.  But  roundabout 
production,  i.e.  production  by  first  making  tools,  ma¬ 
chinery,  etc.,  yields  a  smaller  surplus  the  further  it  is  ex¬ 
tended.  The  more  tools,  machinery,  and  other  capital 
equipment  we  have  (after  a  certain  point  is  reached),  the 
less  desirable  is  it  further  to  increase  this  equipment. 
The  gain  or  surplus  from  so  doing  becomes  smaller  and 
smaller,  yet  for  a  long  time,  perhaps  indefinitely,  remains 
a  gain. 

But  thus  to  extend  the  roundaboutness  of  production 
requires  a  supply  of  goods  for  the  present  maintenance 
of  those  occupied  in  constructing  the  necessary  capital, 
since  they,  being  engaged  in  roundabout  production, 
cannot  secure  this  present  maintenance  from  their 
present  labor.  Possession  of  goods  which  may  serve  as 
means  of  maintenance  for  laborers  during  the  roundabout 
production  process,  enables  production  to  be  carried  on 
thus  indirectly  with  the  consequent  larger  product. 
For  this  reason,  a  surplus  in  future  goods  will  be  paid 
for  a  given  amount  of  present  goods ;  $100  to-day  may 
buy  $105  next  year,  for  $100  to-day  makes  it  possible  to 
turn  away  from  production  for  immediate  needs  and  to 
produce,  by  the  usually  larger  yielding  indirect  method, 
for  the  future.  For  the  use  of  the  present  consumable 
goods  which  make  indirect  production  possible,  a  pre¬ 
mium  will  be  paid  by  those  desiring  control  of  the 
present  goods;  and  this  premium  will  depend  on  the 
gain  which  indirect  production  yields.  The  possessors 
of  command  over  present  goods,  on  the  other  hand,  will 
not  trade  them  for  future  goods  except  for  a  premium, 

1  Not  necessarily,  but  unless  the  indirect  process  is  expected  to  yield  more,  it 
will  not  be  adopted. 


88  ECONOMIC  ADVANTAGES  OF  COMMERCE 


because  these  present  goods  can  be  used  in  support  of 
themselves  and  those  they  hire  and  so  can  make  it  possible 
for  them  to  engage  in  roundabout  production  and  reap 
the  surplus.  To  dispose  of  their  command  over  present 
goods  is,  in  so  far,  to  give  up  this  possibility,  and  they 
will  not  give  it  up  without  compensation.  The  rate  of 
interest,  then,  is  determined,  on  both  the  supply  and 
demand  sides  of  the  market,  —  the  side  of  those  who  want 
and  that  of  those  who  have  command  over  present  goods, 
— by  the  rate  of  surplus  productivity1  of  roundabout  over 
more  direct  production. 

To  recapitulate,  the  more  largely  production  is  round¬ 
about  or  capitalistic,  the  larger  is  the  total  amount  of 
wealth  and  income  yielded ;  the  more  largely  production 
is  capitalistic,  the  less  additional  gain  is  realized  by  the 
further  extension  of  roundabout  production ;  the  greater 
the  accumulations  of  society,  and  the  further  indirect 
production  is  extended,  the  lower  (other  things  equal) 
is  the  rate  of  interest.  Large  accumulations  and  great 
extension  of  roundabout  production  make  social  wealth 
greater,  the  rate  of  interest  lower,  the  rate  of  wages 
higher.  We  saw,  in  the  last  chapter,  that  a  protective 
tariff  tends  to  decrease  the  productive  efficiency  of  a 
country  which  applies  it.  Such  a  tariff  makes  more 
difficult  the  process  of  accumulation.  It  tends  somewhat 
to  lessen  the  degree  of  roundaboutness  in  production,  to 
lessen  the  extent  to  which  production  is  capitalistic. 
Protection,  therefore,  because  it  lessens  national  wealth 
through  turning  industry  into  less  profitable  channels, 
may  lessen  national  wealth  further  by  making  production 
less  capitalistic.  If  it  does  this,  it  will  tend  to  raise  the 
rate  of  interest,  though  not  necessarily  the  total  amounts 

1  At  the  margin  of  indirect  production. 


PROTECTION  AND  DISTRIBUTION 


89 


received  as  interest  since  the  higher  rate  will  be  on  smaller 
capital ;  while  it  will  tend  to  reduce  wages  both  by  giving 
to  capitalists  a  larger  proportion  of  the  results  of  round¬ 
about  production  and  by  making  production,  on  the 
whole,  less  roundabout  and,  therefore,  less  efficient. 
This  indirect  effect  which  a  protective  tariff  may  have  on 
wages,  through  its  effect  on  accumulation  and  the  rate 
of  interest,  is  without  doubt  very  much  less  important 
than  the  more  direct  effect  to  be  next  discussed,  but 
its  operation,  so  far  as  it  does  affect  wages,  is  unfavorable. 

§  2 

Brief  Statement  of  Laws  of  Wages  and  Land  Rent 

The  general  level  of  wages  is  determined,  like  other 
prices,  by  supply  and  demand.  The  wages  which  will 
equalize  supply  of  and  demand  for  labor  will  be  higher 
or  lower  according  as  labor  is  more  or  less  productive. 
Should  the  productivity  of  labor  double,  wages  would 
double.  For  if  labor  would  produce  twice  as  much  as 
before  and  wages  did  not  rise  correspondingly,  the  profit 
to  be  realized  in  hiring  labor  would  be  very  great.  This 
would  increase  the  demand  for  labor  until,  if  wages  did 
not  rise,  demand  would  exceed  supply.  Hence,  wages 
must  rise  and  must  rise  in  proportion.  We  have  refer¬ 
ence  here  to  real,  as  distinguished  from  money,  wages; 
that  is,  to  the  necessaries,  comforts,  and  luxuries  which 
wage  earners  receive,  rather  than  to  the  mere  number  of 
dollars. 

If  all  land  were  equally  fertile  and  all  sites  equally 
good,  and  if  desired  land  and  space  were  unlimited,  wages 
would  equal  the  whole  product  of  labor  except  interest. 
Those  who  advanced  the  means  required  to  make  pro- 


90  ECONOMIC  ADVANTAGES  OF  COMMERCE 


duction  more  roundabout,  would  enjoy  interest ;  beyond 
this,  labor  would  get  the  entire  product  of  industry. 
But  all  land  is  not  equally  fertile ;  all  sites  are  not  equally 
satisfactory;  land  and  space  are  not  unlimited;  and 
there  is  to  be  reckoned  with,  the  great  law  of  diminish¬ 
ing  returns.  Whether  in  agriculture,  manufacturing,  or 
other  work,  an  increase  of  labor  upon  any  given  space  or 
area  will  not,  beyond  a  certain  point,  result  in  a  pro¬ 
portionate  increase  of  the  product.  Two  men,  on  a  100- 
acre  farm,  may  secure  twice  or  more  than  twice  as  great 
a  result  as  can  one.  But  it  is  pretty  certain  that  two 
hundred  men,  working  on  that  farm,  will  not  secure  100 
times  as  large  a  product  as  can  two  men.  So,  in  manu¬ 
facturing,  a  point  of  maximum  economy  is  reached, 
beyond  which  it  does  not  pay  to  crowd  men  together  on  a 
limited  area  or  to  build  story  upon  story,  but  beyond 
which  larger  production  requires  more  land.  Since  all 
land  is  not  equally  good,  this  means  that  larger  production 
requires  the  use  of  less  productive  land  and  sites  than 
would  otherwise  have  to  be  used. 

To  illustrate  the  bearing  of  these  facts  upon  the  theory 
of  wages  and  rent,  let  us  consider  the  case  of  a  100-acre 
farm.  Upon  it,  two  men  might  be  able  to  produce  wheat 
at  the  rate  of  3 120  bushels  a  year  or  an  average  of  60 
bushels  a  week,  three  men  an  average  of  85  bushels  a 
week,  four  men  105  bushels,  five  men  120  bushels.  Then 
the  third  man  adds  25  bushels  to  the  product  which  would 
result  from  two  men’s  work ;  the  fourth  man  would  add 
20  bushels;  the  fifth,  15  bushels.  Suppose  that  wheat 
is  $1  a  bushel.  Then,  if  wages  are  not  more  than  $25 
a  week  but  are  enough  less  to  pay  interest  on  the  wages 
advanced,  the  owner  of  the  land  will  hire  three  men  to 
cultivate  it.  He  will  not  hire  a  fourth,  since  a  fourth  will 


PROTECTION  AND  DISTRIBUTION 


9i 


add  but  20  bushels,  worth  $20,  to  the  product.  If, 
however,  wages  are  slightly  less  than  $20  a  week,  he  will 
hire  four  men;  and  if  they  are  slightly  less  than  $15, 
he  will  employ  five.  The  higher  wages  are,  the  fewer 
men  he  will  employ.  The  lower  wages  are,  the  more  men 
he  will  employ.  This  is  true  of  all  employers.  Some 
land  is  so  poor  that  no  one  can  afford  to  work  it  or  hire 
others  to  work  it,  if  wages  are  high.  If  wages  are  low, 
this  land  can  be  worked  profitably.  In  general,  the 
lower  wages  are,  the  greater  is  the  demand  for  labor. 
More  men  are  desired  on  the  more  productive  sites  and 
men  are  desired  for  the  utilization  of  sites  that  otherwise 
would  stand  undeveloped.  At  any  level  of  wages, 
employers  will  hire  men  up  to  the  point  where  the  last 
man  hired  just  produces  his  wages  or  just  produces  his 
wages  plus  interest. 

To  the  extent  that  industry  is  carried  on  under  nearly 
constant  cost,  a  great  amount  of  labor  can  be  employed 
at  wages  almost  as  high  per  man  as  would  be  paid  to  a 
smaller  number  of  laborers.  Very  little  reduction  of 
wages  is  required  to  increase,  greatly,  the  demand  for 
labor,  since  many  employees  can  be  hired  before  the 
worth  of  the  last  man  (the  marginal  product  of  labor), 
becomes  less  than  his  wages.  If,  on  the  other  hand, 
industry  is  carried  on  under  conditions  of  sharply  in¬ 
creasing  labor  cost  (diminishing  returns),  any  consider¬ 
able  increase  in  the  demand  for  labor  (other  things  equal), 
will  not  take  place  except  at  greatly  reduced  wages.  If, 
therefore,  the  industry  of  a  country  is  forced  into  a  line 
of  sharply  increasing  labor  cost,  real  wages  must  become 
lower ;  though  it  is  likewise  true  that  if  industry  is  forced 
into  a  line  of  constant  labor  cost  into  which  it  would  not 
naturally  go,  real  wages  will  probably  become  lower.1 

1  See  §  s  of  this  chapter  (V  of  Part  II). 


92  ECONOMIC  ADVANTAGES  OF  COMMERCE 


Ignoring  interest,  the  law  of  which  we  have  already 
stated,  the  surplus  of  production  above  the  amounts  paid 
as  wages  constitutes  land  rent  and  goes  to  the  owners  of 
land.  In  our  illustration,  at  wages  of  $20  a  week  or 
slightly  less,  not  more  than  four  men  would  be  employed 
on  the  given  farm.  No  one  of  them  would  be  employed 
at  more  than  $20  wages,  because  no  one  of  the  four  adds 
more  than  20  bushels  or  $20  to  what  the  product  would 
be  without  him.  The  weekly  wages  of  all  four  will  not, 
therefore,  exceed  $80.  The  total  product,  however,  with 
four  men  working,  is  105  bushels  or  $105  worth.  This 
leaves  $25  a  week  as  land  rent  to  the  owner  of  the  farm. 
If  wages  were  lower,  not  only  would  more  men  be  em¬ 
ployed,  but  rent  would  be  higher.  If  wages  were  higher, 
fewer  men  would  be  employed  and  rent  would  be  lower. 
Some  land  will  yield  higher  rent ;  some  is  so  poor  as  to 
yield  no  rent. 

When  protection  turns  the  industry  of  a  country  into 
a  line  which  it  otherwise  would  not  follow,  the  rents  of 
lands  or  sites  required  in  this  line  tend  to  rise,  and  the 
owners  of  these  lands  and  sites  become  more  prosperous. 
On  the  other  hand,  the  rents  of  lands  or  sites  which  were 
used  in  the  lines  from  which  industry  has  been  turned, 
tend  to  fall,  and  the  owners  of  these  lands  and  sites 
become  less  prosperous.  Our  task  is  to  inquire  what,  in 
general,  is  the  effect  of  protection  on  the  total  rent  pay¬ 
ments  and  on  the  general  level  of  real  wages  in  the 
protectionist  country. 


PROTECTION  AND  DISTRIBUTION 


93 


§  3 

The  Effect  of  Protection  on  Wages  when  Protected  and  Un¬ 
protected  Goods  are  Produced  in  the  Protectionist  Coun¬ 
try ,  under  Conditions  of  Substantially  Constant  Cost 

Let  us,  to  begin  with,  consider  the  effect  of  protection 
on  wages,  when  both  protected  and  unprotected  goods 
are  produced,  in  the  protectionist  country,  under  condi¬ 
tions  of  substantially  constant  cost.  Under  these  condi¬ 
tions,  a  tariff  will  not  greatly  affect  land  rent.  The  first 
effect  of  protection  is,  as  we  have  seen,1  to  raise  the  prices 
of  protected  goods  by  not  more  than  the  amount  of  the 
tariff,  without  affecting  money  wages.  The  secondary 
effect  of  protection,  resulting  from  the  inflow  of  money 
(so  far  as  protection  occasions  such  an  inflow) ,  is  to  raise 
prices  of  unprotected  goods  and  money  wages,  and  to 
further  raise  the  prices  of  protected  goods.  Canada’s 
protective  tariff  on  linen  has,  as  its  first  effect,  a  43  cents 
or  a  43  per  cent  rise  in  price  per  yard,  wages  remaining  the 
same,  viz.  about  $20  a  week  (a  week’s  labor  producing 
20  bushels  of  wheat  worth  $1  a  bushel).  The  second 
effect  may  be  to  raise  everything  10  per  cent.  If,  under 
conditions  of  constant  cost  in  all  lines,  there  is  such  a 
general  rise  of  prices  due  to  money  inflow,  we  must 
suppose  that,  until  this  rise  reaches  10  per  cent,  there  will 
be  some  Canadian  goods  still  sufficiently  in  demand  else¬ 
where  to  maintain  the  inflow  of  gold,  though  wheat, 
because  of  competition  from  other  sources,  may  not  be 
such  a  good.  Assuming  such  an  average  secondary 
rise  of  10  per  cent,  and  that  all  goods  are  produced  under 
conditions  of  constant  cost,  this  rise  must  affect  any  one 
kind  of  goods,  e.g.  wheat.  Otherwise,  those  producing 

1  See  Ch.  IV  (of  Part  II),  §§  i  and  2. 


94  ECONOMIC  ADVANTAGES  OF  COMMERCE 


that  kind  of  goods  will  turn  to  some  other  line.  If  wheat 
cannot  be  exported  at  the  higher  price,  only  enough  will 
be  produced  for  home  consumption,  and  the  other  wheat 
producers  will  become  linen  producers,  etc.  Then  the 
total  increase  of  wheat  in  price  is  io  per  cent,  and  of 
money  wages  io  per  cent,  but  of  linen  57  per  cent  (43 
per  cent  and  10  per  cent  more  added  to  the  new  price 
of  $1.43  makes  $1.57).  Obviously,  the  average  wage 
earner’s  condition  is  worse  because  of  the  tariff,  even 
though  his  money  wages  are  somewhat  higher  than 
otherwise  they  would  be.  If  the  protectionist  country 
has  an  inconvertible  money  system  unrelated  to  foreign 
systems,  money  wages  and  unprotected  goods  will  remain 
the  same  in  price  as  before,  while  protected  goods  rise 
in  price.  Wage  earners  will  be  worse  off.  With  a  com¬ 
mon  money  standard,  gold,  for  the  countries  trading, 
prices  in  the  protectionist  country,  even  of  unprotected 
goods,  rise,  and  wages  rise  in  the  same  proportion ;  but 
since  wages  rise  in  no  greater  proportion,  and  since 
protected  goods  do  rise  in  price  by  a  greater  proportion, 
real  wages  are  lower.1 

Our  conclusion  as  to  money  wages  is  only  that  a  high 
tariff  will  tend  to  make  them  higher  in  a  given  country 

A  restrictive  duty  on  the  export  of  wheat  would  cause  an  outflow  of  gold 
and  a  fall  in  the  general  level  of  prices  but  would  likewise  reduce  real  wages. 
The  decreased  market  for  wheat  would  lower  its  price  ih  Canada  and  would 
lower  in  the  same  degree  (assuming  it  to  be  produced  under  conditions  of  con¬ 
stant  cost)  the  money  wages  of  producers.  But  the  price  of  linen,  into  the  pro¬ 
duction  of  which  Canadian  labor  might  in  considerable  degree  be  eventually 
forced,  could  not,  since  Canada  is  at  a  relative  disadvantage  in  its  production, 
fall,  to  the  same  extent,  below  the  price  at  which  it  was  previously  imported. 
At  that  price,  outflow  of  money  for  linen  would  cease.  Under  the  conditions 
of  production  assumed,  Canadians  could  better  afford  to  produce  wheat  even 
for  but  70  cents  a  bushel  than  to  produce  linen  for  appreciably  less  than  $i  a 
yard.  Twenty  bushels  at  70  cents  a  bushel  or  14  yards  at  $1  a  yard  would  alike 
yield  but  $10  a  week.  A  week’s  wages  would  buy  as  much  wheat  as  before  but 
less  linen.  Hence,  real  wages  would  be  lower  because  of  such  a  tax. 


PROTECTION  AND  DISTRIBUTION 


95 


than  they  would  be  in  that  same  country  in  the  absence 
of  the  tariff.  It  does  not  follow  that  money  wages  will 
be,  necessarily,  higher  in  a  protectionist  country  than  in 
a  free  trade  country.  In  a  prosperous  country,  money 
wages  as  well  as  real  wages  will  be,  other  things  equal, 
higher  than  in  a  country  not  prosperous.  In  the  United 
States,  for  example,  average  money  wages,  as  well  as 
average  real  wages,  are  higher  than  in  Europe.  This  is 
due  to  the  fact  that  in  many  lines  we  have  great  natural 
resources  without  having  too  dense  a  population.  We 
are  productive  in  many  lines  of  agriculture,  particularly 
perhaps  in  the  raising  of  wheat,  corn,  and  cotton.  We  are 
also  productive  in  certain  lines  of  manufacture,  having, 
for  example,  in  Pennsylvania  and  in  Alabama,  great 
advantages  for  the  manufacture  of  steel  and  steel  prod¬ 
ucts.  In  these  various  lines  of  effort,  the  United  States 
is  so  productive  that,  even  with  reasonably  low  prices 
received  for  the  goods,  the  daily  wages  of  labor  in  these 
lines  are  high  compared  with  European  standards.  Since 
we  are,  in  these  lines  of  activity,  so  productive,  those  in 
all  other  lines  of  industry  must  get  equally  high  wages  or 
they  will  go  into  these.  That  is,  assuming  open  compe¬ 
tition,  the  national  prosperity  cannot  be  confined  to  any 
one  occupation.  Thus,  since  our  wheat  raisers  and  steel 
producers  are  prosperous,  our  bricklayers,  carpenters, 
plumbers,  etc.,  need  to  be  well  rewarded  to  keep  them  in 
their  work.  Therefore,  the  prices  of  houses  and  of  other 
goods  which  cannot  be  imported,  and  in  producing  which 
this  country  does  not  have  the  superiority  that  it  has  in 
cotton,  wheat,  steel,  etc.,  will  be  high. 

From  these  considerations  it  would  appear  that  if 
wheat,  cotton,  steel,  and  some  other  lines  of  industry  are, 
in  the  United  States,  exceptionally  productive,  it  is  the 


g6  ECONOMIC  ADVANTAGES  OF  COMMERCE 


most  economical  policy  for  us  to  import  other  products 
which  we  can  obtain  more  cheaply  abroad,  rather  than  to 
employ  our  own  high-priced  labor  in  relatively  unpro¬ 
ductive  effort.  The  prosperous  country  ought  to  have 
higher  money  wages,  but  not  higher  prices  of  importable 
commodities  except  as  transportation  and  distributing 
costs  make  them  higher.  The  fact  that  we  have  great 
natural  resources  in  comparison  to  population,  and  that 
our  labor  is  in  some  lines  very  productive,  should  make 
us  immensely  more  prosperous  than  the  older  and  more 
crowded  countries  whose  resources  in  comparison  with 
their  populations  are  much  less  than  ours,  and  should 
make  real  wages  markedly  higher  here.  For  decades 
we  have  had  a  tariff  policy  admirably  adapted  to  raise 
the  cost  of  living  and  decrease  our  prosperity.  If  we 
have  been  prosperous  and  if  our  wages  have  been  high, 
it  has  been  in  spite  of  and  not  because  of  the  tariff. 
Comparing  two  European  countries,  England  and  Ger¬ 
many,  the  former  the  stock  example  of  free  trade,  the 
latter  a  protectionist  country,  we  find  prices  some  18 
per  cent  higher  in  Germany  and  money  wages  lower.1 

1  See  “A  Comparative  Study  of  Railway  Wages  and  the  Cost  of  Living  in 
the  United  States,  the  United  Kingdom,  and  the  Principal  Countries  of  Con¬ 
tinental  Europe,”  Bureau  of  Railway  Economics,  Bulletin  No.  34,  Washington, 
D.C.,  1912,  pp.  11,  35,  and  67.  In  the  same  Bulletin  (p.  11),  it  is  shown  that 
railway  wages  in  the  United  States  in  1900-1910  averaged  $2.23  per  day  as  com¬ 
pared  with  wages  in  England  and  Wales  for  1910  of  $1,067.  It  is  also  shown 
(p.  67)  that  prices  in  the  United  States  for  goods  in  workmen’s  budgets  in  1909 
were  38  per  cent  higher  than  in  England  and  Wales.  It  appears,  therefore, 
that  despite  the  tariff,  naturally  favoring  conditions  have  kept  American  real 
wages  somewhat  higher  than  English  wages,  but  not  so  much  higher  as  a  com¬ 
parison  of  money  wages  alone  might  lead  us  to  suppose.  Comparative  railway 

wages  are  probably  as  good  an  index  of  comparative  wages  in  general  as  is 
available. 


PROTECTION  AND  DISTRIBUTION 


97 


§4 

The  Effect  of  Protection  on  Wages  and  Rent  when  the 
Protected  Goods  are  Produced  under  Conditions  of 
Sharply  Increasing  Cost 

Still  assuming  the  unprotected  product,  wheat,  to  be 
produced  in  Canada  at  so  nearly  constant  cost  that  the 
withdrawal  of  some  labor  into  linen  making  will  not 
appreciably  lower  the  price  of  wheat,  let  us  suppose  the 
conditions  to  be  such  that  linen  manufacturing,  in 
Canada,  can  be  extended  only  at  increasing  cost.  We 
may  suppose,  for  instance,  that  there  are  a  very  few  sites 
favorably  located  near  sources  of  cheap  power  and  on 
transportation  lines,  and  that  upon  these  sites  linen  can 
be  produced,  even  in  Canada,  for  $i  a  yard,  or,  at  worst, 
for  less  than  $1.43.  But  most  of  the  desired  supply,  in 
the  absence  of  protection,  is  obtained  from  Ireland. 
Protection,  by  shutting  out  the  supply  from  abroad, 
encourages  the  use  of  the  poorer  sites  in  Canada,  since 
the  better  sites,  by  our  hypothesis,  cannot  produce 
enough  to  satisfy  the  demand.  To  remunerate  pro¬ 
ducers  on  the  poorer  sites,  the  price  must  be  higher,  say 
$1.43  a  yard.  If  it  is  not,  producers  on  the  poorer  sites 
cannot  pay  the  prevailing  rate  of  wages.  If  it  is,  pro¬ 
ducers  on  the  better  sites  have  a  surplus  or  rent,  since 
production  costs  them,  in  wages,  less  money  per  yard 
than  it  costs  producers  on  the  poorer  sites. 

Otherwise  expressing  the  matter,  we  may  say  that  a 
week’s  labor  in  Canada  will  produce  20  yards  of  linen 
on  the  better  sites,  but  only  14  on  the  poorer  sites.  If 
the  poorer  sites  are  to  be  used,  wages  cannot  be  more  than 
14  yards  a  week  or  the  money  equivalent  of  14  yards. 
But  the  owners  of  the  better  sites  have  a  surplus,  after 


PART  11  —  H 


98  ECONOMIC  ADVANTAGES  OF  COMMERCE 


paying  these  wages,  of  6  yards  or  the  money  equivalent 
of  6  yards. 

So  far,  then,  as  Canada  supplies  itself,  after  the  protec¬ 
tive  policy  is  adopted,  with  Canadian  linen  manufactured 
on  the  most  favorable  sites,  there  is  no  national  loss. 
Wages,  that  is,  real  wages,  are  lower.  The  rents  of  the 
favorable  factory  sites  are  higher.  Money  wages  are  not 
lower,  but  linen  is  higher  in  price,  and  the  rise  goes  to 
increase  the  incomes  of  land  owners.  So  far  as  Canada 
supplies  itself  with  linen  from  the  less  advantageously 
located  factories,  the  higher  price  means  a  loss  to  wage 
earners  with  no  corresponding  gain  to  the  owners  of  land. 
Under  the  conditions  of  production  here  assumed  (pro¬ 
duction  of  linen  under  conditions  of  increasing  cost  and 
of  wheat  at  nearly  constant  cost),  the  protective  tariff 
would  indeed  decrease  the  net  wealth  and  income  of  the 
protectionist  country,  but  the  land  owning  class  would 
gain.1  Rents  of  lands  required  for  the  protected  industry 
(assumed  to  be  of  increasing  cost)  would  rise  to  a  greater 
degree  than  rents  of  lands  required  for  unprotected  in¬ 
dustries  (assumed  to  be,  within  limits,  of  nearly  constant 
cost)  would  fall.  The  total  national  loss  in  yearly  income 
would  therefore  be  less  than  the  loss  of  the  wage  earning 
class  alone.  Part  of  the  loss  of  the  wage  earning  class 
would  be  absolute  national  loss ;  the  rest  would  be  loss 
balanced  by  land  owners’  gain. 

No  essential  corrections  need  to  be  made  in  these  con¬ 
clusions  because  of  the  inflow  of  money  resulting  from 

1  A  similar  result,  except  that  there  would  be  an  outflow  of  money  and  a  fall 
of  money  prices,  would  follow,  under  our  assumptions,  from  a  restrictive  export 
duty  on  wheat.  Such  a  duty  would  prevent  production  of  wheat  for  export, 
drive  some  Canadian  labor  into  other  lines,  e.g.  the  manufacture  of  linen,  even 
though  for  small  returns,  reduce  real  wages,  and  raise  the  rents  of  land  and  sites 
required  in  the  newly  expanded  lines  of  industry. 


PROTECTION  AND  DISTRIBUTION 


99 


protection.  Under  the  assumed  conditions,  the  second¬ 
ary  rise  of  prices  so  caused  would  affect  rents,  wages,  and 
nearly  all  prices,  alike. 

Duties  of  the  special  kind  here  criticised,  we  have  had 
in  plenty  in  our  own  various  protective  tariff  acts.  Our 
protective  tax  on  coal,  compelling  resort  to  the  poorest 
native  mines  in  preference  to  securing  some  coal  from 
abroad,  has  doubtless  tended  to  increase  the  value  of 
native  mines  and  the  profits  of  mine  owners,  but  has  done 
this  only  at  the  greater  expense  of  the  wage  earning  pub¬ 
lic.  The  protection  accorded  to  raw  wool  by  the  much 
criticised  schedule  K  of  the  Payne-Aldrich  tariff  bill, 
certainly  tended  to  encourage  the  production  of  wool 
in  the  United  States  on  lands  which,  otherwise,  it  would 
not  have  paid  to  use  for  that  purpose.  The  owners  of 
lands  used  for  sheep  raising  were  doubtless  in  many  cases 
able  to  realize  larger  profits  or  higher  rents,  but  only  at 
the  greater  expense  of  others,  largely  the  wage  earners. 

In  estimating  the  relative  costs  of  production  of  raw 
wool  in  different  countries  and  in  different  parts  of  the 
United  States,  the  Tariff  Board  subtracted  the  receipts 
to  sheep  raisers  from  other  things  than  the  wool,  chiefly 
from  mutton.  There  was  left,  in  their  reckoning,  a  cost 
which  the  wool  must  cover.  This  surplus  cost  they  found 
to  be  nothing  in  New  Zealand  and  on  the  favorably  sit¬ 
uated  runs  of  Australia,  a  very  few  cents  a  pound  for 
Australasia  in  general,  4  or  5  cents  a  pound  for  South 
America,  9!  cents  a  pound  for  the  United  States, 
11  cents  for  the  “fine”  and  “fine  medium”  wools  of  the 
American  west,  and  19  cents  for  the  fine  wools  of  Ohio 
and  the  contiguous  territory.1  The  effect  of  protection 

1  Report  of  the  Tariff  Board  on  Schedule  K  of  the  Tariff  Law,  1912,  Vol.  I, 
Part  I,  pp.  10,  11. 


ioo  ECONOMIC  ADVANTAGES  OF  COMMERCE 

(now,  fortunately,  removed  from  raw  wool)  has  been  to 
shut  out  very  largely  the  lower  priced  foreign  wool, 
to  compel  the  use  of  the  high-priced  American  wool,  to 
make  wool  production  profitable  on  lands  relatively 
unsuited  for  it,  to  make  the  rental  value  of  these  lands 
higher,  and  to  make  real  wages  lower.  In  the  opinion 
of  the  tariff  board,  the  highest  production  cost  in  the 
world,  of  the  merino  wools  largely  required  by  American 
mills,  is  in  the  state  of  Ohio  and  near-by  surrounding 
territory ; 1  yet  a  high  protective  tariff  on  raw  wool  so 
shut  off  the  supply  from  abroad  as  to  cause  large  produc¬ 
tion  of  it  in  that  region.  That  the  general  effect  of  this 
protection  to  raw  wool,  accorded  by  the  Payne-Aldrich 
tariff  bill,  must  have  been  to  lower  wages  while  probably 
raising  the  rents  of  land  owners,  hardly  seems  open  to 
serious  question. 

§5 

The  Effect  of  Protection  on  Wages  and  Rent  when 

Unprotected  Goods  are  Produced  under  Conditions  of 

Sharply  Increasing  Cost 

We  may  now  consider  a  third  possibility  as  to  costs  of 
production,  viz.  that  the  protected  goods,  e.g.  linen,  are 
produced  under  conditions  of  nearly  constant  cost, 
while  the  unprotected  goods,  e.g.  wheat,  are  produced 
under  conditions  of  increasing  cost.  Under  these  cir¬ 
cumstances,  not  much  labor  can  be  turned  into  linen 
manufacturing  without  lowering  the  marginal  labor  cost 
of  producing  wheat.  For  as  labor  is  diverted  from 
wheat  to  linen  production,  the  poorer  wheat  lands  are 
deserted,  and  on  the  better  lands  a  week’s  labor  can 
produce  more  than  20  bushels.  If,  therefore,  Canada’s 

Report  of  the  Tariff  Board  on  Schedule  K  of  the  Tariff  Law,  1912,  Vol.  I, 
Part  I,  pp.  10,  11. 


PROTECTION  AND  DISTRIBUTION 


IOI 


tariff  effectively  excludes  foreign  linen,  either  Canadian 
linen  will  sell  for  more  than  $1.43  a  yard  or  Canadian 
wheat  for  less  than  $1  a  bushel  or  both  such  changes  will 
occur.  Otherwise  no  one  will  desert  any  but  the  very 
worst  wheat  lands  in  order  to  produce  linen.  Competi¬ 
tion  of  wheat  raisers  who  would  rather  sell  wheat  for  less 
than  $1  a  bushel  than  linen  for  only  $1.43  a  yard  will 
tend  to  keep  wheat  prices  down.  Reluctance  of  such 
persons  to  produce  linen  will  tend  to  keep  linen  prices  up. 
The  ratio  of  the  value  of  a  bushel  of  wheat  to  the  value  of 
a  yard  of  linen  must  he  at  such  a  point  that  returns  to 
marginal  producers  (i.e.  producers  having  the  least  favor¬ 
able  situations,  but  whose  goods  are  nevertheless  de¬ 
manded),  shall  be  about  equal  in  both  lines.  Hence,  it 
will  take  more  than  20  bushels  of  wheat  to  equal  in  value 
14  yards  of  linen.  If  Canada  were  financially  isolated 
and  the  quantity  of  money  in  Canada  remained  un¬ 
changed,  we  should  expect  that  the  changed  conditions 
of  cost  would  be  accompanied  by  both  a  rise  of  linen 
and  a  fall  of  wheat  prices.  Unless  there  was  an  increased 
quantity  of  currency  in  Canada,  a  rise  of  the  price  of  linen 
above  $1.43  a  yard  could  hardly  take  place  (other  things 
equal)  without  a  fall  in  the  price  of  wheat  below  $1 ;  and 
unless  there  was  a  decreased  supply  of  currency,  wheat 
could  hardly  fall  below  $1  without  there  being  a  rise  in 
the  price  of  linen  above  $1.43. 

But  with  Canada  maintaining  a  gold  standard,  the 
common  standard  of  most  of  the  commercial  world,  and 
having  a  foreign  market  for  her  wheat,  the  price  of  the 
wheat  cannot  greatly  fall.  Any  tendency  of  the  price 
to  fall,  in  Canada,  would  be  counteracted  by  exportation 
and  sale  abroad  at  world  market  prices.  Any  change  in 
relative  values  will  be  through  a  rise  in  price  of  linen 


102  ECONOMIC  ADVANTAGES  OF  COMMERCE 

above  $1.43,  rather  than  through  a  fall  in  price  of  wheat 
below  $1.  Since  importations  of  goods  into  Canada 
are  interfered  with,  there  must  be  for  a  time  a  net  money 
inflow,  and  there  must  be  a  money  inflow  for  wheat  if 
and  so  long  as  it  sells  for  much  less  than  $1  a  bushel. 
This  inflow  of  money  into  Canada  tends  to  raise  average 
prices  in  the  proportion  of  the  money  inflow.  Were  the 
wheat  produced  under  conditions  of  approximately 
constant  cost,  the  inflow  of  money  must  necessarily  tend 
to  raise  its  price  in  the  same  proportion.  For,  since  it 
raises  prices  generally  in  that  proportion,  the  industry  of 
wheat  raising  must  yield  correspondingly  larger  money 
returns  or  it  would  be  less  profitable  than  others.  But 
under  conditions  of  increasing  cost,  the  circumstances  are 
different.  On  the  better  lands,  the  profits  of  wheat  rais- 
ing,  even  with  the  higher  money  cost  of  production  and 
at  a  price  little  if  at  all  higher  than  before  the  tariff  was 
laid,  will  be  sufficient  to  keep  those  lands  under  cultiva¬ 
tion.1  Rather  than  turn  to  the  protected  industries,  such 
as  linen  manufacture,  until  Canada  only  produces  enough 
wheat  for  her  own  use  and  has  none  for  export,  and  until 
wheat  has  risen  in  price  in  the  same  ratio  that  money  has 
increased,  Canadian  farmers  on  the  better  lands  will 
prefer  to  remain  producers  of  wheat.  This  will  result 
in  a  supply  sufficient  to  keep  the  price  from  rising  very 
much  above  the  former  price.  In  fact,  if  we  assume 
wheat  production  to  be  the  line  of  industry  in  which 
Canada  is  relatively  the  most  efficient  and  wheat  to  be 
Canada’s  chief  or  only  export,  we  must  conclude  that 
Canadian  wheat  cannot  rise  to  a  much  higher  price  than 
before,  despite  the  inflow  of  money.  For  wheat  can  be 
secured  in  large  quantities  from  many  other  sources  of 

1  Though  less  intensively  than  before. 


PROTECTION  AND  DISTRIBUTION 


103 


production,  and  if  Canadian  wheat  rises  greatly  in  price, 
foreign  demand  for  Canadian  wheat  will  decrease, 
Canadian  producers  on  the  poorer  lands  will  give  up 
wheat  production,  and  Canadian  producers  on  the  better 
lands  will  accept  world  wheat  market  prices  rather  than 
abandon  wheat  production.  The  sale  abroad  of  Ca¬ 
nadian  wheat  and  of  nothing  else  cannot,  by  causing  an 
inflow  of  gold,  raise  the  price  of  Canadian  wheat  very 
much  above  this  world  market  price,  since,  before  it  does 
so,  foreign  purchase  of  Canadian  wheat  will  cease,  the 
inflow  of  gold  will  cease,  and  the  rise  of  prices  will 
cease.1 

Assume  that,  as  a  result  of  protection,  Canadian  money 
increases  by  10  per  cent.  We  have  seen  that  average 
prices  will  tend  to  rise  by  10  per  cent,  in  addition  to  the 
original  43  per  cent  rise  of  the  protected  linen.  We  have 
seen  that,  under  our  supposed  conditions,  wheat  prices 
will  remain  substantially  unchanged.  Since  wheat  re¬ 
mains  at  about  $1  a  bushel,  linen  will  rise  to  more  than 
Si. 5 7  a  yard  and  wages  will  rise  to  more  than  $22  a 
week.2  It  follows  that  there  is  a  possibility  of  gain,  for 
wage  earners,  from  a  limited  application  of  protection; 
though,  as  we  shall  see,  the  probability  of  this  gain  being 
realized  in  practice  is  remote.  So  far  as  they  are  con¬ 
sumers  of  protected  goods,  wage  earners  lose  because 
of  the  rise  in  prices  of  these  goods,  occasioned  by  the 
tariff.  But  so  far  as  wage  earners  are  able  to  buy  at 
substantially  the  former  prices,  goods  produced  under 
conditions  of  increasing  cost,  while  having  money  wages 

1  Canadian  prices  cannot  rise  indefinitely  in  relation  to  foreign  prices  unless 
Canada  is  such  a  centre  of  gold  production  that  prices  rise  without  export  of 
goods  and  unless,  also,  all  imports  are  forbidden,  and  so  outflow  of  this  gold  is 
prevented. 

2  That  is,  by  more  than  io  per  cent  on  $  20. 


104  ECONOMIC  ADVANTAGES  OF  COMMERCE 

greater  by  more  than  the  average  rise  of  prices,  with 
which  to  buy  these  goods,  they  are  gainers. 

On  the  other  hand,  owners  of  land  —  in  this  case, 
farming  land  are  losers.  And  they  lose  more  than 
wage  earners  gain.  Land  which  it  previously  paid  to 
cultivate  can  no  longer  be  cultivated  with  profit.  Land 
which  previously  yielded  a  large  surplus,  after  wages 
were  paid,  now  yields  a  smaller  surplus.  Since  the  wheat 
land  owners  (and  that  means,  in  large  part,  the  farmers), 
get  practically  no  higher  prices  for  their  wheat,  the  higher 
money  wages  which  they  have  to  pay  are  to  them  an 
unbalanced  loss.  So  are  the  higher  prices  they  must  pay 
for  protected  and  other  goods.  Their  loss  through  having 
to  pay  higher  wages  to  those  they  employ  is  not  cancelled 
for  the  nation  as  a  whole  by  a  corresponding  gain  to  their 
employees,  since  the  latter  have  to  pay  higher  prices  for 
linen.  Neither  are  the  higher  prices  which  farmers  and 
other  land  owners  must  pay  for  linen  balanced  by  the 
higher  money  wages  paid  to  linen  makers,  for  these 
wages  are  higher  only  by  virtue  of  the  secondary  rise 
resulting  from  the  inflow  of  gold  (the  original  43  cents 
rise  directly  due  to  the  tariff  merely  making  it  possible 
to  get  the  same  wages  in  linen  making  as  were  previously 
given  in  wheat  producing) ;  while  both  the  original  rise 
which  does  not  raise  wages  and  the  secondary  rise  which 
does,  must  be  borne  by  farmers  desiring  to  purchase 
linen.  It  seems  fair  to  conclude,  therefore,  that  if  wage 
earners  ever  do  gain  by  a  protective  tariff,  they  gain  at 
the  greater  expense  of  farmers  or  some  other  class. 

As  shown  in  the  previous  chapter,  average  wealth  is 
decreased. 

The  conclusion  that  a  protective  tariff  establishing  an 
industry  of  relatively  constant  cost,  and  decreasing  the  ex- 


PROTECTION  AND  DISTRIBUTION 


105 


tent  of  an  industry  of  increasing  cost,  might  raise  wages 
at  the  expense  of  land  rent,  applies  equally  if  we  suppose 
the  protectionist  country  to  have  an  inconvertible  paper 
money  which  will  not  be  increased  by  an  inflow  of  gold. 
Suppose  Canada  to  have  such  a  currency.  Then,  as  we 
have  seen,1  the  original  rise  of  linen  to  $1.43  is  not  fol¬ 
lowed  by  the  10  per  cent  further  rise  in  the  average  of 
prices.  But  the  value  relation  of  foreign  money  to 
Canadian  money  will  change,2  so  that  it  takes  more  for¬ 
eign  money  than  before  to  buy  a  given  amount  of 
Canadian  money,  and  therefore  of  Canadian  goods.  To 
tempt  wheat  producers  away  from  any  but  the  worst 
lands  will  require  a  rise  of  linen  above  $1.43.  On  the 
other  hand,  the  price  of  wheat  will  fall  below  $1  a  bushel, 
since  it  can  be  produced  more  cheaply  on  the  better  lands 
and  since  the  greater  value  of  Canadian  money  compared 
to  foreign  money  will  prevent  the  export  of  any  wheat 
except  at  less  than  fia  bushel.  Money  wages  will  remain 
about  the  same,  $20  a  week.  Wheat  will  be  cheaper. 
Wage  earners  may  be  better  off,  but,  if  so,  only  at  the 
expense  of  even  greater  loss  to  agricultural  land  owners.3 

The  possible  gain  of  wage  earners  and  loss  to  agricul¬ 
tural  land  owners  and  farmers,  can  perhaps  be  most 
clearly  shown  if  we  omit  reference  to  money  and  money 
prices.  When  the  Canadian  tariff  shuts  out  linen  from 
abroad,  the  value  of  linen,  in  Canada,  will  rise  in  terms 

1  Chapter  IV  (of  Part  II),  §  3. 

2  See,  for  example,  Part  I,  Ch.  VI,  §§  6,  7,  8,  9,  and  Part  II,  Ch.  IV,  §  3. 

3  A  restrictive  export  tax  on  wheat  might  have  a  like  result  on  the  relative 
interests  of  economic  classes,  though  having  an  opposite  result  on  the  general 
price  level.  Such  a  tax  would  cause  prices  to  fall  and  would  drive  industry 
from  wheat  raising  into  other  lines.  But  it  might,  conceivably,  by  preventing 
production  of  wheat  for  export  and  forcing  out  of  cultivation  the  poorer  lands, 
reduce  wheat  prices,  in  Canada,  more  than  it  reduced  prices  in  general  or  money 
wages. 


io6  ECONOMIC  ADVANTAGES  OF  COMMERCE 


of  wheat  until  it  becomes  profitable  for  men  to  leave  off 
cultivating  the  less  fertile  and  less  desirably  situated 
lands,  in  order  to  manufacture  linen.  Instead  of  20 
bushels  buying  20  yards,  as  before,  when  the  linen  was 
purchased  abroad,  20  bushels  will  buy  less  than  14  yards 
and  14  yards  will  buy  more  than  20  bushels.  For  if 
14  yards  of  linen  would  buy  but  20  bushels  of  wheat, 
only  those  on  the  very  worst  lands,  if  even  those,  would 
find  it  profitable  to  change  from  wheat  to  h’nen  produc¬ 
tion.  If,  when  a  new  equilibrium  is  reached,  the  worst 
lands  still  cultivated,  and  the  marginal  labor  on  all 
wheat  lands,  yield  25  bushels  a  week  per  cultivator,1 
while  it  requires  a  week’s  labor  to  make  14  yards  of 
linen,  then  25  bushels  will  exchange  for  14  yards.  Since 
considerable  labor  is  diverted  into  linen  manufacture  at 
a  wage  of  not  more  than  14  yards  (or  its  equivalent  in 
other  form),  a  week’s  wages  in  wheat  production  will 
be  not  more  than  and  not  much  less  than  25  bushels  a 
week  (or  the  equivalent  in  other  form).  At  any  appre¬ 
ciably  less  wage,  demand  for  labor  would  exceed  supply, 
because  at  any  less  wage  it  would  pay  to  hire  more  men, 
to  cultivate  land  more  intensively,  and  to  cultivate 
worse  land,  while  at  any  less  wage,  labor  could  not  so 
easily  be  kept  from  the  linen  factories  and  at  work  on 
the  farms.  Wages  in  terms  of  linen  are  less  (14  yards  in¬ 
stead  of  20)  because  of  the  tariff.  Wages  in  terms  of 
wheat  are  greater  (25  bushels  instead  of  20)  because  of 
the  tariff.  If  the  wage  earner  has  occasion  to  consume 
much  wheat  and  to  use  little  linen,  his  real  wages,  in 
this  very  hypothetical  case,  will  be  higher.2  Owners  of 

1  That  is,  if  the  last  man  hired  adds  that  much  to  the  total  product.  See 
§  2  of  this  chapter  (V  of  Part  II). 

2  Cf.  Loria  in  the  Journal  of  the  Royal  Statistical  Society,  Vol.  L,  on  “Effects 
of  Import  Duties  in  New  and  Old  Countries,”  1887,  PP-  408-410;  Patten, 


PROTECTION  AND  DISTRIBUTION  107 

•  1 

wheat  lands,  including  farmers,  will  lose  what  the 
wage  earners  they  hire  gain,  and  will  lose,  besides, 
from  the  higher  price  of  linen  in  terms  of  wheat.  The 
wheat-producing  wage  earners  will  not  gain  in  real  wages 
what  the  farmers  who  pay  them  lose,  for  it  will  take  more 
wheat  than  before  to  buy  14  yards  of  linen.  Neither 
will  the  linen-making  workmen  gain  as  much  from  the 
higher  price  of  linen  in  terms  of  wheat,  as  the  wheat 
producers  and  owners  of  wheat  lands  lose,  for  the  linen 
makers  gain  what  the  wheat  raisers  and  land  owners  lose, 
only  to  the  extent  that  they  trade  their  linen  wages  for 
wheat.  So  far  as  they  themselves  have  some  use  for 
linen,  they  also  lose. 

We  are  brought  back,  then,  by  another  route,  to  the 
conclusion  that  a  protective  tariff  will  only  add  to  the 
wealth  or  income  of  one  person  or  class  by  taking  a  larger 
amount  of  wealth  or  income  away  from  some  other 
person  or  class.1  It  is  conceivable,  though,  as  we  shall 

Economic  Basis  of  Protection,  Philadelphia  (J.  B.  Lippincott  Co.),  1895,  Ch. 
V;  and  Bastable,  The  Theory  of  International  Trade,  fourth  edition,  London 
(Macmillan),  1903,  p.  105. 

1  A  number  of  economists  ( e.g .  Sidgwick,  Edgeworth,  Carver)  have  appar¬ 
ently  been  led  to  the  opinion  that  protection  might  not  only  raise  wages  but 
might  even  increase  the  total  national  wealth  by  drawing  labor  out  of  lines  of 
increasing  cost;  or  that  the  removal  of  protection  to  manufactures  and  other 
industries  of  relatively  constant  cost  might  decrease  national  productiveness  as 
well  as  reduce  wages.  Sidgwick,  for  instance,  imagined  a  protectionist  country 
of  limited  natural  resources  suddenly  becoming  a  free  trade  country,  and  its 
manufacturing  population,  previously  protected,  being  thereupon  undersold  by 
foreigners  and  driven  out  of  business  and  being  unable  to  obtain  employment 
in  agriculture  (The  Principles  of  Political  Economy,  London,  Macmillan,  1887, 
pp.  496-498).  But  if  agricultural  resources  were  in  such  a  country  so  limited 
as  to  give  little  or  no  employment  to  the  former  manufacturing  population, 
then  this  population  would  remain  chiefly  or  entirely  in  manufacturing,  accept¬ 
ing  the  lower  wages  required  for  competition  with  the  imported  goods.  This, 
however,  could  not  possibly  decrease  the  national  wealth  (except  as  the  reduced 
wages  might  affect  efficiency)  for  the  land  owners  would  gain  as  much  as  the  wage 
earners  would  lose.  Employment,  at  some  level  of  wages,  would  continue,  and 
production  would  continue.  If,  with  removal  of  protection,  it  proved  possible 


io8  ECONOMIC  ADVANTAGES  OF  COMMERCE 


see,  far  from  probable,1  that  wage  earners  may  be  the 
gamers  and  land  owners  the  losers  by  such  a  policy. 

Let  no  one  welcome  this  conceivable  consequence  of  a 
carefully  devised  tariff  system,  on  the  ground  that  the 
situation  or  fertility  rent  secured  by  the  owners  of  supe¬ 
rior  land,  is  unearned.  Assuming  that  it  is  unearned  (and 
it  is  no  part  of  the  function  of  this  book  to  discuss  at 
length  whether  or  not  land  rent  is  unearned),  a  change  in 
the  taxing  system  securing  to  the  public  its  full  rights 
to  any  such  unearned  wealth  or  income  would  be  more 
sensible  than  a  partial  loss  of  such  wealth  or  income 


to  employ  more  productively  in  agriculture  even  a  few  of  those  previously  en¬ 
gaged  in  manufacturing,  the  total  national  wealth  would  be  increased  even  though 
wages  might  fall.  The  discussions  on  this  phase  of  protection  between  Profes¬ 
sors  Bastable  and  Edgeworth,  in  the  Economic  Journal  (Vol.  X,  1900,  pp.  389- 
393  and  Vol.  XI,  1901,  pp.  226-229  and  582-590)  seem  to  the  present  writer 
not  to  bring  out  clearly  this  distinction  between  the  effect  on  national  wealth 
and  the  effect  on  wages.  (See  also  Bastable,  The  Theory  of  International  Trade, 
pp.  187-197.) 

Carver  (Publications  of  the  American  Economic  Association,  Third  Series, 
Vol.  Ill,  pp.  176-182)  uses  a  different  illustration  to  establish  what  seems  to 
be  the  same  conclusion  as  that  of  Sidgwick.  He  supposes  a  piece  of  land  which, 
in  the  absence  of  protection  or  some  form  of  legal  discrimination,  will  allow  the 
employment  of  one  man  in  sheep  raising,  while  it  might  otherwise  employ  20 
men  in  wheat  production..  The  total  product,  he  assumes,  would  be  greater 
in  the  latter  case ;  but  the  land  owners’  rent,  if  trade  were  thus  interfered  with, 
would  be  lower.  Removal  of  restrictions  might  throw  19  men  out  of  work.  In 
criticism  of  this  view  it  is  to  be  said  that  there  are  two  extreme  possibilities. 
Either  the  19  men  have  a  preferable  alternative,  under  the  free  trade  regime,  to 
wheat  raising,  or  they  have  not.  If  they  have  not,  they  will  accept  low  enough 
wages,  rather  than  be  unemployed  and  have  nothing,  so  that  the  land  owner 
can  realize  as  much  rent  for  his  land  (or  more)  as  if  he  used  it  for  a  sheep  run. 
Unless  their  efficiency  is  thus  impaired,  they  will  then  produce  as  much  wheat 
as  if  they  were  protected.  The  effect  of  freedom  from  restriction  may  be  seen 
in  lower  wages  and  higher  rent,  but  not  in  decreased  national  wealth.  If,  how¬ 
ever,  they  have  a  preferable  alternative,  these  19  men  will  not  raise  wheat  but 
will  occupy  themselves  otherwise  at  higher  wages  than  wheat  raising  under 
free  trade  would  yield  them,  while  the  land  owner  will  at  the  same  time  realize 
the  higher  rent  assumed  to  result  from  using  his  land  as  a  sheep  run.  Free 
trade  would  then,  also,  raise  rent  more  than  it  would  lower  wages. 

1  Shown  in  remainder  of  this  section  (5). 


PROTECTION  AND  DISTRIBUTION 


109 


because  of  restrictions  on  trade.  At  any  rate,  those 
who  support  protection  with  the  argument  that  it  can 
be  made  to  benefit  wage  earners  at  the  expense  of  land 
rent,  should  be  the  last  to  oppose  direct  taxation  of  rent. 

In  practice,  the  likelihood  of  devising  a  tariff  which 
shall  benefit  wage  workers  at  the  expense  of  farmers  is 
extremely  small.  Such  a  tariff  must,  in  the  first  place, 
turn  enough  labor  from  agriculture  into  other  fines  to 
raise,  appreciably,  the  margin  of  cultivation.  That  is, 
so  much  of  the  poorer  land  previously  cultivated  must 
be  left  uncultivated,  that  the  poorest  land  remaining  in 
use  is  appreciably  better  than  the  poorest  land  which 
was  in  use.  Otherwise,  wages  in  terms  of  wheat  cannot 
be  appreciably  higher,  for  owners  of  the  poorer  lands 
cannot  pay  higher  wages,  and,  unless  labor  is  so  strongly 
drawn  into  other  fines  that  they  have  to,  owners  of  the 
better  lands  will  not.  To  have  any  appreciable  favorable 
effect  on  wages,  protection  must,  therefore,  set  up  large 
industries  or  many  industries,  giving  employment  to 
many  men. 

But  if  protection  is  to  be  of  benefit  to  wage  earners,  it 
must  be  levied  on  goods  consumed  not  at  all  or  only  to  a 
very  limited  extent  by  them,  and  on  no  other  goods,1 
so  that  any  rise  of  money  wages  which  may  take  place, 
shall  not  be  more  than  offset  by  higher  prices  of  goods 
workingmen  have  to  buy.2  The  problem  of  drawing  a 
large  amount  of  labor  away  from  agriculture  (usually 
regarded  as  an  industry  of  increasing  cost,  though  it  is 
by  no  means  always  an  industry  of  rapidly  increasing 

1  Or,  at  least,  only  slightly  on  other  goods. 

2  This  loss  to  wage  earners  is  borne  not  the  less  if  they  buy  goods  made  by 
machinery  which  has  been  raised  in  price  by  protection,  or  transportation  from 
railway  companies,  etc.,  which  have  to  charge  more  because  of  expensive  ma¬ 
terials. 


no  ECONOMIC  ADVANTAGES  OF  COMMERCE 


cost)  into  industries  ( e.g .  many  kinds  of  manufacturing) 
of  relatively  constant  cost,  and  selecting,  as  industries 
into  which  to  draw  this  labor,  only  those  producing  goods 
little  used  by  the  masses,  is  indeed  a  problem  hard  to 
solve  and  a  problem  which,  in  the  exigencies  of  practical 
politics,  is  unlikely  ever  to  be  solved. 

As  a  matter  of  fact,  few  men  in  practical  politics  would 
dare  advocate  such  protection,  frankly  stating  its  in¬ 
tended  result  and  how  the  result  was  to  be  attained ;  for 
most  men  in  politics  would  quickly  realize  that  such  an 
advocacy  would  be  likely  to  array  against  them  the  oppo¬ 
sition  at  the  polls  of  nearly  all  the  farmers.  Our  own 
(United  States)  protective  tariff  has  been  levied  on  raw 
wool,  woolen  cloth,  cotton  cloth,  sugar,  fruit,  potatoes, 
shoes,  coal,  etc.  It  has  been  very  far  from  being  a  tariff 
which  would  raise  wages  at  the  greater  expense  of  rent. 
Rather  has  it  been  a  general  grab  in  which  as  many 
interests  as  possible  have  tried  to  get  something  at  the 
expense  of  the  general  interest.  It  requires  no  argument 
to  show  that  our  protection  has  not  been  designed  to 
avoid  the  things  that  the  masses  of  working  people  have 
to  consume.  Nor  has  it  by  any  means  avoided  goods 
produced  under  conditions  of  increasing  cost,  protection 
of  which  is  likely  to  raise  land  rents,  to  the  greater  loss 
of  wage  earners.  From  the  log  rolling  of  actual  political 
struggle,  there  is  likely  to  issue  a  hodge-podge  of  tariff 
rates,  causing  loss  to  nearly  all.  The  general  average 
of  American  wages  might  be  made  higher  by  shutting  out 
the  immigrant  laborers  who  enter  this  country  as  com¬ 
petitors  of  those  already  here ;  but  the  average  American 
real  wages  are  distinctly  not  raised  by  shutting  out  and, 
therefore,  making  scarce  and  dear,  the  goods  which  wage 
workers  desire  to  consume. 


PROTECTION  AND  DISTRIBUTION 


hi 


§6 

How  Protection  May  Benefit  One  Section  of  a  Country  at 
the  Expense  of  Other  Sections 

A  protective  tariff  may  benefit  absolutely  one  section 
of  a  country,  including  manufacturers,  wage  earners,  and 
farmers ;  but  if  so,  only  at  the  greater  expense  of  some 
other  section  or  sections.  Protection  to  manufacturers 
of  woolen  cloth,  in  certain  sections  of  New  England,  may 
benefit  people  in  those  sections,  who  are  unwilling  to 
move  elsewhere,  by  making  purchasers  of  cloth  in  other 
parts  of  the  United  States  pay  tribute  to  them.  It  may 
conceivably  even  work  a  benefit  to  farmers  and  farm 
land  owners  in  the  immediate  vicinity  of  the  protected 
mills,  since  the  protected  mill  owners  and  mill  workers, 
though  gaining  something  at  the  expense  of  the  rest  of  the 
nation,  would  have  to  share  these  gains  with  local  dairy¬ 
men  and  truck  farmers  in  order  to  get  the  latters’  ser¬ 
vices,  just  as  they  would  have  to  share  these  gains  with 
local  building  contractors,  bricklayers,  and  so  forth.1 
The  gain,  if  there  is  a  gain,  is  not  equivalent  to  the  loss 
of  other  sections,  for  the  people  of  the  locality  benefited 
have  the  option  of  seeking  better  opportunities  in  these 
other  sections,  even  if  they  do  not  care  to  carry  on  other 
industries  where  they  are.  If  other  sections  have  greater 
resources,  then  artificially  to  prevent  migration  into  them 
is  to  diminish  national  prosperity,  is  to  decrease  wealth 
production  in  the  naturally  favored  sections  more  than  it 
is  increased  in  the  less  favored.  And,  in  any  case,  to 
turn  industry  into  a  fine  it  would  not  otherwise  follow, 
is,  presumably,  to  diminish  national  prosperity.  The 
policy,  when  all  sections  are  considered,  brings  a  net  loss. 

1  Cf.  Taussig,  Principles  of  Economics ,  New  York  (Macmillan),  1911,  Vol.  I, 
p.  six. 


1 12  ECONOMIC  ADVANTAGES  OF  COMMERCE 

While  there  is  reasonable  ground  for  the  opinion  that  no 
large  section  of  the  United  States  has  really  gained 
by  the  long  continued  maintenance  of  protective  duties, 
or  could  gain  more  than  it  would  lose,  in  the  general 
compromise  of  protective  tariff  making,  yet  certain 
parts  of  the  country  have  felt  themselves  particularly 
injured.  This  has  been  the  feeling  in  most  of  the 
Southern  states,  and  is  one  explanation  for  the  phenom¬ 
enon  of  a  “solid  South.”  The  cotton-raising  states  have 
realized  that  their  staple  product  must  be  in  part  ex¬ 
ported,  and  that  a  protective  tariff  could  not  appre¬ 
ciably,  if  at  all,  raise  its  price.  And  they  have  known 
full  well  that  the  prices  of  many  things  they  have  had 
to  buy  have  been  very  considerably  raised  in  price  by  the 
tariff.  The  wheat-producing  areas  of  the  middle  West 
and,  doubtless,  certain  manufacturing  centres  of  the  East, 
have  been  in  a  similar  situation. 

It  is  probably  such  facts  as  these,  which  have  appar¬ 
ently  produced  in  the  minds  of  some  of  our  public  men 
the  feeling  that  a  protective  tariff  is,  in  spirit,  unconsti¬ 
tutional,  a  feeling  which  found  recent  expression  in  the 
National  Democratic  platform  of  1912.  The  Federal 
Constitution  has  given  to  Congress  and  the  President 
the  right  to  levy  import  duties  and  the  right  to  regulate 
commerce  with  foreign  nations.  The  passing  of  a 
protective  tariff  law  has  always  been  regarded  as  but  an 
exercise  of  these  powers.  There  is  little  reason  to  sup¬ 
pose  that  any  Federal  court  would  set  aside  a  tariff  law  as 
unconstitutional  merely  because  it  was  protective.  A 
court  would  not  be  likely  to  go  behind  the  professed 
intent  of  Congress  and  the  letter  of  the  Constitution,  in 
order  to  raise  questions  regarding  the  ultimate  economic 
effects  of  the  laws  passed.  Such  questions  would  be 


PROTECTION  AND  DISTRIBUTION 


113 

assumed  to  be  questions  for  the  legislature  and  not  the 
judiciary  to  decide.  Therefore,  Congress  and  the  Presi¬ 
dent  must  themselves  decide  upon  the  constitutional 
justification  of  a  protective  tariff.  But  the  contention 
that  to  use  either  the  tax-levying  power  or  the  power  to 
regulate  commerce,  in  such  a  way  as  to  compel  the  people 
of  some  states  to  pay  tribute  to  producers  in  other  states, 
is  contrary  to  the  real  spirit  of  a  constitution  framed  as 
the  basis  for  a  federation  of  states,  is  a  contention  not 
without  a  degree  of  plausibility. 

§7 

Protection  as  an  Encouragement  to  Monopoly 

In  its  practical  results,  the  tariff  is  likely  to  operate 
in  taxing  the  entire  nation,  not  for  the  benefit  of  all  the 
people  in  any  one  section,  but  for  the  protection  of  mo¬ 
nopoly  profits.  Though  a  tariff  schedule  may  not  be  at 
first  devised  for  this  purpose,  —  and  of  course  it  would 
not,  at  least  openly,  be  so  devised,  —  it  comes  to  have 
this  effect  if  it  encourages  combination.  This  the  tariff 
is  likely  to  do.  For  it  protects  producers  against  foreign 
competition  and  so  suggests  to  them  the  hope  that,  by 
combining  among  themselves,  they  may  realize  monopoly 
profits.  A  protective  tariff  which  has  only  this  effect 
cannot  be  said  to  benefit  the  masses  of  the  people  in  any 
section.  It  certainly  has  no  effect  on  real  wages  other 
than  to  lower  them,  if,  as  is  usually  the  case,  the  goods 
produced  are  goods  largely  consumed,  directly  or  in¬ 
directly,  by  working  people.  For  the  only  way  the  tariff 
can  possibly  create  or  maintain  monopoly  profits,  is  to 
create  or  maintain  monopoly  prices ;  and  that  means  that 
it  takes  money  from  the  masses  of  the  people,  in  order  to 
give  it  to  monopolists. 


part  n  —  1 


1 14  ECONOMIC  ADVANTAGES  OF  COMMERCE 

§8 

Summary 

We  have  now  to  summarize  the  conclusions  we  have 
reached  regarding  the  effect  of  protection  on  classes  and 
sections.  Because  protection  tends  to  diminish  national 
wealth,  it  has  a  tendency  to  restrict  the  extent  of  round¬ 
about  production,  to  make  the  rate  of  interest  higher 
(though  not  necessarily  the  total  amount  of  interest), 
and  to  make  wages  lower.  This  is  an  indirect  effect. 
But  there  is  a  more  obvious  direct  action.  When 
both  protected  and  unprotected  goods  are  produced,  in 
the  protectionist  country,  under  conditions  of  approxi¬ 
mately  constant  cost,  the  effect  of  protection  is  to  reduce 
real  wages.  If  the  protectionist  country  and  those 
trading  with  it  have  a  common  monetary  standard,  then 
money  wages  in  the  former  will  rise  and  money  prices 
will  rise  in  the  same  proportion,  except  that  there  will  be 
a  special  rise  of  the  protected  goods,  in  addition,  so  that 
real  wages  will  be  lower.  Assuming  the  protected  in¬ 
dustry  to  be  one  of  increasing  cost,  while  the  unprotected 
industries  are  of  relatively  constant  cost,  it  appears  that 
protection  may  benefit  land  owners  by  raising  land  rents, 
but  that  the  gain  of  land  owners  must  be  less  than  the  loss 
of  wage  earners. 

On  the  other  hand,  there  is  a  conceivable  case  in  which 
wage  earners  gain  at  the  greater  expense  of  land  owners, 
viz.  when  the  protected  goods  are  produced  under  con¬ 
ditions  of  relatively  constant  cost  and  unprotected  goods 
under  conditions  of  increasing,  perhaps  sharply  increas¬ 
ing,  cost,  and  when  wage  earners  are  chiefly  concerned, 
as  consumers,  with  unprotected  goods.  Given  these 
conditions,  real  wages  will  be  higher  because  of  protection. 


PROTECTION  AND  DISTRIBUTION 


US 

and  the  rents  of  land  (in  our  illustration,  the  profits  of 
farmers)  will  be  lower.  But  the  owners  of  land  lose  more 
than  the  wage  earners  gain.  Assuming  the  usual  inter¬ 
national  monetary  relations,  money  wages  will  rise; 
money  prices  of  protected  goods  will  rise  more ;  money 
prices  of  the  unprotected  goods  produced  under  condi¬ 
tions  of  increasing  cost  will  rise  little  or  not  at  all. 

It  appeared,  however,  that  the  mere  devising  of  a 
tariff  to  have  this  result  would  be  difficult,  since  it  would 
be  almost  impossible  to  divert  much  labor  from  the  indus¬ 
try  or  industries  of  increasing  cost  and  so  to  make  possible, 
in  that  industry  or  those  industries,  higher  wages,  without 
protecting  the  production  of  and  raising  the  prices  of, 
goods  largely  consumed  by  wage  workers.  The  practical 
difficulties  in  the  way  of  passing  such  a  tariff  act  ap¬ 
peared  to  be  no  less  great.  The  conflict  of  various 
interests  is  not  likely  to,  and  presumably  never  did, 
result  in  a  tariff  act  which  would  raise  wages  at  the  ex¬ 
pense  of  land  rent.  Even  supposing  such  an  act  to  be 
practically  possible,  and  assuming  that  most  or  all  of 
land  rent  is  an  unearned  income  belonging  properly  to 
the  whole  people,  we  must  conclude  that  direct  taxa¬ 
tion  of  such  rent  would  secure  the  larger  general  welfare 
and  the  less  waste,  as  compared  with  the  indirect  and  very 
partial  appropriation  of  it  and  partial  waste  of  it,  in¬ 
volved  in  the  protective  tariff  policy. 

Protection  can,  it  was  shown,  benefit  a  considerable 
territory  within  the  protected  group  at  the  greater 
expense  of  another  section  of  the  same  nation.  In  the 
United  States,  the  South  has  usually  felt  itself  to  be  a 
sufferer  by  the  policy.  Protection  may  also  build  up  and 
secure  against  foreign  competition,  monopolies,  and  so 
injure  the  general  public  for  the  benefit  of  a  compara¬ 
tively  few. 


CHAPTER  VI 


A  Consideration  of  Some  Special  Arguments  for 

Protection 


The  Argument  that  Protection  is  Desirable  Because  it 
Keeps  Money  in  the  Protected  Country 

One  of  the  cruder  popular  arguments  for  protection 
is  that  it  keeps  the  people  of  the  protectionist  country 
from  spending  their  money  in  foreign  countries,  and  so 
gets  and  keeps  more  money  in  circulation  at  home.  It 
is,  of  course,  true,  as  we  have  seen,1  that  the  effect  of 
a  protective  tariff  is  to  decrease  imports,  while  still,  for 
a  short  time,  not  bringing  about  a  corresponding  decrease 
of  exports,  and  that  there  is,  in  consequence,  somewhat 
more  money  in  a  protectionist  country  than  otherwise 
there  would  be.  But  it  is  also  true  that  the  net  inflow 
of  money  or  of  gold  is  not  perpetual,  that  it  soon  reaches 
a  limit.  It  is  further  to  be  emphasized  that  money  or 
gold  is  not  the  thing  for  the  securing  of  which  trade  is 
really  carried  on.  No  one,  other  than  a  miser,  wants 
money,  except  that  he  may  pay  it  out  again  for  other 
goods. 

The  argument  in  favor  of  getting  money  into  the 
country  and  keeping  it  there,  occasionally  takes  the  form 
of  a  comparison  between  a  business  man  and  a  nation. 
It  is  asserted  that  a  business  man  is  reckoned  prosperous 

1  Chapter  IV  (of  Part  II),  §  i. 

116 


SPECIAL  ARGUMENTS  FOR  PROTECTION  117 


in  proportion  as  he  takes  in  more  money  than  he  pays 
out,  in  proportion  as  he  sells  more  goods  than  he  buys ; 
that  a  nation’s  prosperity  is  similarly  to  be  secured  by 
selling  for  money  more  than  it  buys  with  money;  and 
that,  therefore,  a  limitation  on  purchases  from  abroad 
is  desirable. 

The  validity  of  such  a  comparison  is  sometimes  ques¬ 
tioned  by  free  traders.  It  is  said  that,  since  a  nation 
is  not  the  same  as  a  single  individual,  what  conduces  to 
the  prosperity  of  the  latter  may  not  further  the  prosper¬ 
ity  of  the  former.  But  free  traders  have,  as  such,  no 
occasion  to  question  the  validity  of  the  comparison, 
since  the  comparison  does  not  show  what  protectionists 
intend  it  to  show.  The  fact  is  that  a  successful  busi¬ 
ness  man  does  not  take  in  more  money  than  he  pays  out. 
On  the  contrary,  he  is  always  anxious  to  expend  his 
money  (or  his  bank  deposit)  for  goods.  If  he  does  not 
spend  it  for  enjoyments,  he  will  wish  to  expend  it  by 
making  investments.  He  will  buy  automobiles,  yachts, 
residences,  theatre  tickets ;  or  he  will  purchase  factories, 
office  buildings,  railroad  shares,  machinery.  It  is  by 
the  one  type  of  purchases  that  he  endeavors  to  enjoy  his 
prosperity,  and  by  the  other  kind  of  purchases  that  he 
hopes  to  add  to  his  prosperity.  A  wealthy  man  is  not 
necessarily  one  who  has  a  large  amount  of  money  in  his 
pockets  or  one  who  has  a  large  checking  account.  More 
usually  his  assets  of  that  sort  are  small  compared  with 
his  property  in  railroads,  mills,  stores,  farms,  etc.  With 
a  nation,  which  is  a  collection  of  individuals,  the  aim 
should  be  similar.  A  nation  enjoys  its  prosperity,  in 
proportion  as  it  secures  many  services  and  many  goods 
for  immediate  consumption.  It  increases  its  prosperity 
in  proportion  as  it  secures,  from  abroad  if  it  can  get  more 


II*  ECONOMIC  advantages  of  commerce 

by  purchasing  abroad,  large  capital  equipment  for  aid 
in  further  production.  For  a  nation  as  for  an  individ¬ 
ual,  money  is  not  the  thing  most  to  be  desired,  but  the 
wealth  which  money  buys.  A  country  which  has  a 
large  amount  of  money  and  high  prices,  benefits  from  that 
fact  only  if  it  can  use  this  money  to  buy  goods  where 
prices  are  lower.  There  is  no  gain,  but  only  loss,  in 
preventing  purchase  abroad  in  order  to  get  and  keep 
money  within  a  protectionist  nation. 


The  Wages  Argument  for  Protection 

The  argument  for  protection,  which  has,  perhaps,  been 
most  persistently  urged  in  political  campaigns  within 
the  United  States  during  the  last  half  century  or  more, 
is  the  wages  argument.  We  have  already  discussed  at 
some  length  the  effect  of  protection  on  wages,1  and  need 
not  expand  greatly  upon  the  subject,  here. 

The  general  tendency  of  protection  is  to  divert  industry 
out  of  its  most  profitable  into  less  profitable  channels ; 
and  it  is  hardly  likely  that,  by  so  doing,  protection  will 
make  wages  higher.  We  may  rather  expect  that  it  will 
make  wages  lower.  In  fact,  as  we  have  seen,2  a  protec¬ 
tive  tariff  cannot  directly 3  raise  any  wages  without 
raising,  in  the  same  degree,  the  prices  of  protected  goods. 
And  further,  as  we  have  also  seen,4  to  the  extent  that 
protection  operates  to  turn  men  into  less  productive 
lines,  those  whose  wages  are  nominally  raised  will  not 

1  See  Ch.  V  (of  Part  II). 

2  Chapter  IV  (of  Part  II),  §  2. 

3  The  improbability  of  a  tariff’s  raising  wages  indirectly  has  been  sufficiently 
discussed  in  Ch.  V  (of  Part  II),  §  5. 

4  Chapter  IV  (of  Part  II),  §  2. 


SPECIAL  ARGUMENTS  FOR  PROTECTION  119 


gain  (if  they  do  gain)  as  much  as  others  lose.  Even  if 
they  secure,  in  the  protected  industry,  wages  as  much 
higher  than  they  could  otherwise  get  in  that  line  as  their 
employers  get  higher  prices  for  the  protected  goods, 
they  will  not  be  getting  wages  correspondingly  higher 
than  they  could  have  secured  in  the  natural  and  relatively 
more  productive  industries  of  their  country.  The  pre¬ 
sumption  is,  that  not  only  average  real  wages,  but 
even  the  real  wages  of  those  employed  in  protected 
industries,  will  be  lowered  by  protection.  For  compe¬ 
tition,  so  far  as  it  is  free,  tends  to  equalize  condi¬ 
tions;  and  no  one  trade  of  wage  earners  can  there¬ 
fore  hope  to  gain,  for  any  long  period,  by  means  of 
protection,  even  at  the  greater  expense  of  wage 
earners  in  other  trades.  Rather  will  all  probably 
share,  ultimately,  in  the  national  loss.  Though  wages 
measured  in  money  may  be  slightly  higher  under  pro¬ 
tection  because  of  an  inflow  of  gold,  wages  measured 
in  the  necessaries,  comforts,  and  luxuries  of  life,  are 
practically  certain  to  be  lower. 

The  emphasis,  in  the  wages  argument  for  protection, 
is  sometimes  placed  on  the  alleged  danger  of  allowing 
American  workingmen  to  be  subject  to  the  competition 
of  cheap  foreign  labor,  the  competition  of  the  so-called 
“ pauper  labor”  of  Europe.  The  truth  is  that  the 
“competition”  of  cheap  foreign  labor  cannot  do  other¬ 
wise  than  benefit  the  country  as  a  whole.  Such  labor, 
e.g.  labor  engaged  in  the  production  of  woolen  cloth,  can 
only  injure  American  workingmen  employed  in  that 
industry,  by  benefiting  Americans  in  all  other  lines 
through  lower  prices  of  woolen  cloth.  And  the  Ameri¬ 
cans  engaged  in  manufacturing  woolen  cloth  would  share 
in  this  benefit  when  they  had  turned  their  efforts  into 


120  ECONOMIC  ADVANTAGES  OF  COMMERCE 

other  lines  in  which  their  relative  efficiency  was 
greater.  If  it  is  really  so  dangerous  to  American  wage 
workers’  prosperity  to  have  goods  from  abroad  sold 
in  the  United  States  at  a  low  price,  and  the  more 
dangerous  the  lower  the  price,  then,  obviously,  it 
must  be  the  most  dangerous  of  all  if  the  goods  are 
given  to  us  for  nothing.1  What  ruin  to  our  in¬ 
dustries,  what  poverty  and  suffering  must  be  caused, 
by  our  getting  quantities  of  goods  from  abroad  with¬ 
out  having  to  produce  any  goods  to  send  in  return  ! 
For  if  we  thus  secure  goods  from  other  countries  for 
nothing,  we  are  able  to  devote  all  our  energies  to  in¬ 
creasing  still  further  our  stock  of  wealth  and  our  flow 
of  income  services. 

Frequently  an  inductive  wages  argument  is  attempted, 
based  on  a  comparison  between  the  United  States  and 
England.  Attention  is  called  to  the  fact  that  wages  in 
England  are  lower  than  wages  in  the  United  States,  and 
it  is  implied,  if  not  asserted,  that  the  difference  is  due 
to  the  British  policy  of  free  trade  as  contrasted  with 
an  historic  American  policy  (now,  however,  possibly  in 
process  of  abandonment)  of  protection.  Yet  every  one 
who  is  familiar  with  and  able  to  distinguish  between  the 
legitimate  and  the  illegitimate  processes  of  reasoning, 
knows  that  such  a  comparison  has  little  or  no  value 
unless  other  things  are  equal,  or  unless  the  effects  of  the 
other  things  which  are  not  equal  are  known,  and  can  be 
subtracted  from  the  total  result.2  As  a  matter  of  fact, 
other  things  are  not,  in  this  comparison  between  England 
and  the  United  States,  at  all  equal.  England  is  much 


1  An  effective  turn  to  the  argument  given  by  Henry  George  in  his  very  read¬ 
able  Protection  and  Free  Trade,  New  York  (Henry  George),  1891,  pp.  121-125. 
See  Mill,  System  of  Logic ,  Book  III,  Ch.  VIII,  §  5  on  the  method  of  residues. 


SPECIAL  ARGUMENTS  FOR  PROTECTION  121 


more  crowded  than  the  United  States,  and  its  resources, 
in  comparison  to  population,  are  less.  With  thirty- 
three  millions  of  people  struggling  to  make  a  living  in  a 
country  about  the  size  of  the  state  of  Illinois  (which  has 
a  population  of  something  like  two  millions),  England 
can  hardly  be  expected  to  be  a  country  of  as  high  wages 
as  the  United  States.  Because  of  the  law  of  diminishing 
returns,  wages  in  England  must  be  comparatively  low 
in  order  that  the  demand  for  labor  shall  equal  the  supply. 
It  is  true  that  the  people  of  England  are  not  confined  to, 
and  are  not  mainly  occupied  in,  agriculture.  England 
is  primarily  a  manufacturing  and  commercial  nation. 
But  the  point  is,  that  England  has  to  engage  in  indus¬ 
tries  employing  many  persons  per  unit  space,  in  order 
to  support,  comfortably,  so  large  a  population  in  so  small 
an  area.  Hence,  England  has  to  engage  in  commerce 
and  manufacturing ,  even  if  competition  with  other 
crowded  countries  and  parts  of  countries,  reduces  the 
profits  and  wages  which  can  be  earned  to  a  comparatively 
low  level,  and  even  though  far  distant  markets  must 
be  sought  and  raw  materials  imported,  at  considerable 
expense,  from  abroad.  In  a  country  like  the  United 
States,  however,  there  is  always  the  alternative  of  going 
into  agriculture,  or  mining,  or  manufacturing  for  which 
resources  are  available  near  at  hand,  and  hence  wages 
tend  to  remain  at  a  higher  level.  Wages  in  the  United 
States  have  been  high,  not  because  of  a  protective 
tariff  which  has  tended  to  lower  them,  but  because  of 
the  favorable  relation  of  population  to  natural  resources. 
Wages  in  the  United  States  are  in  danger  of  being  low¬ 
ered,  not  by  free  trade,  which  would  tend  to  raise  them, 
but  by  immigration  from  the  crowded  and  low-wage 
countries,  by  immigration  which  increases  the  supply 


i22  ECONOMIC  ADVANTAGES  OF  COMMERCE 


of  labor,  lowers  the  margin  of  cultivation  toward  foreign 
levels,  and  makes  necessary  low  wages  to  equalize  supply 
of  and  demand  for  wage  earners’  services.1 

§  3 

The  Make-Work  Argument  for  Protection 

Closely  associated  with  the  wages  argument  is  the 
argument  that  protection  makes  employment.  It  is 
said  that  the  tariff,  by  shutting  out  various  foreign  goods, 
gives  encouragement  to  American  capital  and  labor  to 
engage  in  producing  such  goods.  If  protection  does  this, 
it  is  only  because  protection  makes  the  production  of 
such  goods  more  profitable.  For  even  without  the  de¬ 
fence  of  the  tariff,  home  producers  in  any  industry  could 
have  the  entire  home  market  and  could,  therefore,  sell 
all  the  goods  which  that  market  would  take  —  as  well 
as  some  goods  abroad  —  if  they  would  make  low  enough 
prices,  if  employers  and  employees  together  would  be 
willing  to  carry  on  the  business  without  aid,  and  take 
what  it  could  earn.  The  tariff  simply  enables  them  to 
do  a  business  no  larger,  at  higher  prices,  and  therefore 
at  the  expense  of  persons  in  other  industries.  If  em¬ 
ployment  is  increased  in  one  industry,  it  is  only  because 
that  industry  is  made  more  profitable  than  it  otherwise 
would  be  and  because  men  will  choose  the  employment 

1  If  immigrant  wage  earners  always  went  into  the  lowest  grade  labor,  and 
if  they  and  their  descendants  remained  in  this  labor  only,  their  competition  might 
not  lower  wages  in  other  work.  If  it  increased  the  demand  for  other  work  more 
than,  by  pushing  former  low  grade  labor  into  such  work,  it  increased  the  supply, 
wages  in  this  other  work  might  rise.  Conceivably,  most’  native  labor  would 
find  employment  in  this  high  grade  work  (Hadley,  Economics,  New  York 

Putnam  ,  1906,  pp.  420-421).  But  in  a  few  generations,  the  descendants  of 
immigrants  are  competing  for  the  higher  positions  as  well  as  the  lower,  and, 
indeed,  it  would  be  more  difficult  to  realize  democratic  ideals  if  they  were  not 
The  net  result  is  likely  to  be'  a  reduction  of  wages  for  most  kinds  of  labor. 


SPECIAL  ARGUMENTS  FOR  PROTECTION  123 


that  pays  best.  Employment  is  made  less  profitable  in 
other  industries  than  it  would  else  be,  since  those  em¬ 
ployed  in  these  industries  must  bear  the  tariff  burden. 
Will  not  the  protective  tariff,  therefore,  decrease  employ¬ 
ment  in  these  other  industries  as  much  as  it  increases 
employment  in  the  favored  industry  or  industries  ? 

Another  way  to  look  at  this  matter  of  employment 
is  from  the  viewpoint  of  the  tariff’s  effect  on  foreign 
trade.  In  a  previous  chapter  1  it  was  pointed  out  that 
any  serious  restriction  of  imports  brings,  eventually,  a 
corresponding  limitation  on  exports.  It  follows  that 
to  give  employment  in  a  new  industry  started  by  a  pro¬ 
tective  tariff,  is  to  take  away  employment  in  production 
of  goods  for  export. 

Even  if  the  people  of  foreign  countries  would  give  us 
our  imports  for  nothing,  —  which  they  will  not,  —  so 
that  our  labor  would  not  need  to  be  employed  in  produc¬ 
ing  goods  to  return  to  them,  still  our  labor  might  be 
sufficiently  employed  in  producing  additional  goods  or 
in  producing  goods  of  a  different  kind  which  we  could 
not  secure  by  gift.  A  high  protective  tariff  would  shut 
out  the  free  goods  and  compel  our  labor  to  be  wasted  in 
producing  these  goods  at  home ;  but  it  would  not  make 
employment  greater  or  more  steady.  Our  labor  would 
simply  be  producing  goods  which  might  have  been  got 
for  nothing,  instead  of  getting  such  goods  free  and  pro¬ 
ducing  additional  goods. 

Labor  can  be  employed,  and  at  high  wages,  when 
there  are  fertile  lands  or  good  sites  to  work  upon,  tools 
to  use,  available  wealth  to  pay  and  support  labor  during 
the  process  of  production  (if  roundabout),  and  a  prospect 
of  a  return  sufficient  to  compensate  for  the  outlay.  A 

1  Chapter  IV  (of  Part  II),  §  i. 


124  ECONOMIC  ADVANTAGES  OF  COMMERCE 


protective  tariff  does  not  increase  or  improve  the  lands 
or  the  sites ;  it  does  not  multiply  tools  or  increase  wealth, 
but  tends  rather  towards  national  poverty ;  it  does  not, 
for  industry  as  a  whole,  improve  the  prospects  for  large 
returns,  but  has,  rather,  the  reverse  effect.1  How,  then, 
can  a  protective  tariff  increase  employment? 

§4 

The  Home  Market  Argument  for  Protection 

In  political  struggle,  it  is  usually  fatal  to  antagonize 
any  very  large  class.  So  in  order  to  carry  through  a 
protective  policy,  it  has  been  necessary,  in  the  United 
States,  to  convince  not  only  wage  workers,  but  farmers  as 
well,  that  the  policy  would  benefit  them.  While  many 
products  of  the  farms,  e.g.  raw  wool,  have  been  protected, 
yet  it  has  been  difficult  to  show  that  the  great  agricul¬ 
tural  staples,  such  as  wheat,  corn,  and  cotton,  have  been 
appreciably  raised  in  price  by  the  tariff  2  or  that  the  tariff 
could  directly  raise  their  prices.  The  appeal  to  American 
farmers  has  therefore  taken  the  form,  in  part,  of  assert¬ 
ing  an  indirect  benefit  of  protection,  through  the  estab¬ 
lishment  of  a  “home  market.”  The  “home  market 
argument”  points  out,  to  begin  with,  that  a  protective 
tariff  increases  the  number  of  persons  engaged  in  the 
protected  industries,  e.g.  manufacturing.  Those  thus 

1  The  Arguments  of  Schiiller  (Schutzzoll  und  Freihandel,  Vienna  —  Tempsky  — , 
and  Leipzig  — Frey  tag — ,  1905,  pp.  75-84)  to  the  effect  that  industry  in  any 
country  is  not  rigidly  limited  by  the  factors  of  production,  but  may  vary 
within  wide  limits  in  relation  to  these  factors,  proves  nothing  whatever  for  pro¬ 
tection,  unless  it  is  also  shown  that  industry  is  likely  to  fall  short  of  its  maximum, 
under  free  trade,  and  more  nearly  to  approximate  its  maximum,  under  protec¬ 
tion.  For  such  a  contention  (aside  from  possible  transitional  effects  during 
adjustment  to  a  changed  policy),  there  seems,  to  the  present  writer,  no  reason¬ 
able  justification  either  in  theory  or  in  direct  experience. 

2  See  Ch.  V  (of  Part  II),  §  5. 


SPECIAL  ARGUMENTS  FOR  PROTECTION  125 


led  to  engage  in  manufacturing  then  have  to  buy  the 
products  of  the  farms,  and  so  the  farmers  secure  a  home 
market  for  these  products. 

The  answer  to  such  an  argument  has  already  been 
indicated  in  our  discussion  of  the  effects  of  a  protective 
tariff  on  exports.1  If  we  of  the  United  States  refuse  to 
buy  goods  from  abroad,  and  so  develop  the  production 
of  those  goods  at  home,  to  just  that  extent,  in  the  long 
run,  will  we  be  deprived  of  an  opportunity  to  produce 
goods  profitably  for  export.  The  farmers  can  only  gain 
a  home  market  by  losing  a  foreign  market.  And  the  extra 
prices  they  have  to  pay  for  goods,  especially  protected 
goods,  because  of  the  tariff,  will  cause  them  to  suffer  a 
net  loss. 

Sometimes  the  argument  in  favor  of  the  development  of 
a  home  market  takes  a  slightly  different  form.  Instead 
of  its  being  asserted  that  the  protected  manufacturing 
industries  will  not  exist  or  will  not  be  so  widely  ex¬ 
tended  without  a  tariff,  emphasis  is  placed  on  the  conten¬ 
tion  that  they  will  not  be  so  prosperous.  Those  engaged 
in  them  will  earn  less.  If  the  manufacturing  industries 
are  protected,  it  is  urged,  the  farmers  may,  indeed,  have 
to  pay  more  for  manufactured  goods ;  but  those  engaged 
in  manufacturing  will  then  have  more  money  with  which 
to  purchase  the  farmers’  products,  and  so  the  farmers 
will  get  their  money  back  again.  The  truth  is  that  they 
will  not  and  do  not  get  it  back  again  unless  they  give 
something  else  of  value  in  return.  If  a  farmer  pays  more 
for  clothes,  because  of  a  protective  tariff,  than  he  other¬ 
wise  would,  we  may  admit  that  the  clothes  makers  will 
have  more  money  (other  things  equal)  with  which  to 
buy,  if  they  choose  to,  the  farmer’s  products;  but  the 

1  Chapter  IV  (of  Part  II),  §  1. 


126  ECONOMIC  ADVANTAGES  OF  COMMERCE 

farmer  does  not  get  back  this  extra  money  for  nothing ; 
he  must  give  extra  products  for  it.  To  assume  that  the 
farmer  does  not  have  to  give  extra  products  to  get  back 
the  additional  money  paid  for  the  higher  priced  clothes, 
is  to  assume  that  the  protected  industry  is  not  encour¬ 
aged  by  the  higher  prices  the  farmer  pays  for  its  goods ; 
for  this  is  to  assume  that  the  higher  prices  so  paid  by  the 
farmer  for  the  protected  goods,  are  balanced  by  higher 
prices  which  those  in  the  protected  industry  must  pay 
for  the  farmer’s  products.  This  would  mean  no  change 
in  the  relative  positions  of  farmer  and  manufacturers 
because  of  protection,  save  a  merely  nominal  change. 
The  idea  which  protectionists  who  use  this  “get  it  back 
again”  argument  endeavor  to  convey  is  that,  somehow, 
producers  of  protected  goods  get  larger  real  incomes 
because  of  the  tariff;  while,  at  the  same  time,  those 
whose  purchases  of  goods  at  higher  prices  make  these 
larger  incomes  possible,  lose  nothing  by  the  system. 

The  absurdity  of  such  an  argument  is  perhaps  best 
shown  by  an  illustration.  Suppose  that,  in  a  small  town, 
there  are  a  number  of  robberies,  as  a  result  of  which  each 
of  the  merchants  of  the  town  finds  himself  minus  several 
hundreds  of  dollars.  Finally,  the  thief  is  apprehended. 
But  upon  being  accused  of  his  crimes,  he  asserts  in  his 
own  defence  that  he  has  really  done  no  harm.  Though 
he  admits  having  robbed  the  various  merchants  of 
money,  yet  he  points  out  that  he  has  lived  in  the  town 
and  has  used  all  of  this  money  to  buy  their  goods  and 
that  thus  they  have  “got  it  back  again.”  The  obvious 
fact  is,  of  course,  that  the  merchants  have  only  got  their 
money  back  by  giving  up  for  it  other  goods  of  supposedly 
equal  value.1 

1  Cf.  Sumner,  Protectionism,  New  York  (Holt),  1885,  p.  125. 


SPECIAL  ARGUMENTS  FOR  PROTECTION  127 


Protection  may,  as  we  have  seen,1  benefit  one  section 
of  a  country  at  the  expense  of  other  sections;  and  the 
gains  to  the  section  benefited  will  perhaps  be  distributed 
among  all  classes.  If  the  West  and  the  South  are  taxed 
to  develop  manufacturing  in  Rhode  Island,  the  Rhode 
Island  truck  farmers  and  dairymen  may  share  in  the 
local  gains  by  virtue  of  having  a  home  market  provided 
for  them  at  the  expense  of  others.  But  to  say  this  is 
very  different  from  saying  that  they  would  gain  if  the 
local  market  were  provided  entirely  at  their  own  expense. 

§5 

The  Argument  for  Protection  to  Agriculture  in  the  Older 
Countries  against  a  Future  when  Cheap  Foods  and 
Raw  Material  may  not  be  Obtainable  from  the  Newer 
Countries 

An  argument  not  generally  familiar  to  Americans, 
has  been  used  in  favor  of  protection  to  the  agriculture 
of  the  more  crowded  European  countries,  in  particular 
the  agriculture  of  Germany.2  There  is,  it  is  claimed, 
too  great  a  reliance  of  the  older  and  more  densely  settled 
countries  upon  the  new  countries  for  food  supplies  and 
raw  materials.  Eventually  the  new  countries  will  be 
more  thickly  settled,  will,  like  the  old,  devote  themselves 
in  larger  part  to  manufacturing,  and  will  have  smaller 
surpluses  of  food,  etc.,  for  export.  Therefore,  the  old 
and  thickly  settled  countries,  which  will  probably  have 
grown  still  more  in  population  during  the  period  of 
importing  food  and  raw  materials  from  abroad,  will  get 

1  Chapter  V  (of  Part  II),  §  6. 

2  See  Adolph  Wagner,  Agrar-  und  Industriestaat,  Jena  (Gustav  Fischer),  1901, 
p.  73.  A  good  statement  of  the  argument  is  given  in  Taussig,  Principles  of 
Economics,  New  York  (Macmillan),  1911,  Vol.  I,  pp.  534,  535. 


128  ECONOMIC  ADVANTAGES  OF  COMMERCE 


their  food  supplies  and  raw  material  with  increasing  diffi¬ 
culty.  The  suggested  remedy  is  that  the  thickly  settled 
countries  should  levy,  each,  a  protective  tariff  on  such 
imports,  force  its  people  to  get  along,  in  the  main,  with 
what  can  be  produced  in  their  own  country,  resist  thus 
the  tendency  to  specialize  in  manufacture,  and  so 
prevent  the  growth  of  a  population  which  is  dependent 
upon  foreign  surpluses  for  its  food  and  necessary  mate¬ 
rials. 

If  the  fear  is  that  the  new  countries,  when  they  come 
to  develop  manufactures,  will  almost  without  exception 
shut  out,  by  protective  tariffs,  goods  manufactured  in 
the  older  countries,  and  so  eventually  compel  the  latter 
to  be  self-sufficient,  there  is  reason  in  the  suggestion  that 
these  older  countries  remain  self-sufficient  from  the 
beginning.  By  so  doing,  they  will  avoid  the  intense 
suffering  which  must  result  from  a  return  to  a  sparseness 
of  population  capable  of  securing  sufficient  food,  etc., 
at  home. 

But  if  the  world  can  be  expected  to  attain  a  liberal 
attitude  towards  trade,  if  a  tendency  towards  low  tariffs 
can  be  hoped  for  (and  this  is  perhaps  more  likely  to  be 
the  case  as  the  stage  of  infant  industry  is  left  behind), 
then  the  argument  for  protection  of  agriculture  has  very 
little  force.  For  no  matter  how  extensively  the  now 
sparsely  settled  countries  eventually  go  into  manufac¬ 
turing,  they  will  not  go  into  it,  if  not  artificially  encour- 
aged,  unless  it  yields,  on  the  average,  as  satisfactory 
returns  as  agriculture.1  That  manufacturing  popula¬ 
tions  in  the  older  countries  will  have  to  meet  the  compe¬ 
tition  of  manufacturing  groups  in  the  newer,  is  true. 
But  assuming  free  trade  (and  if  trade  is  not  free,  then  in 

1  On  the  margin  of  production. 


SPECIAL  ARGUMENTS  FOR  PROTECTION  129 


proportion  as  restrictions  are  slight),  this  merely  means 
that  the  manufacturing  populations  of  the  older  countries, 
cannot  charge  higher  prices  and  therefore  cannot  get 
higher  wages  and  profits  per  unit  product,  than  the  manu¬ 
facturing  groups  in  the  newer  countries.  It  does  not 
mean  that  the  condition  of  the  old  countries  must  be¬ 
come  appreciably  worse  than  that  of  the  new.  So  long 
as  many  persons  in  the  new  countries  care  to  engage  in 
manufacturing  (and  that  they  will  do  so  is  all  that  is 
feared) ,  it  must  be  that  manufacturing  is  about  as  profit¬ 
able  as  agriculture.  If  it  were  much  less  so,  assuming 
free  trade  or  any  near  approximation  to  free  trade,  the 
newer  countries  would  withdraw  from  manufacturing  and 
the  older  countries  could  carry  it  on  without  competi¬ 
tion.  If  manufacturing  in  the  new  countries  is  as  prof¬ 
itable  as  agriculture,  and  if  trade  is  free,  manufacturing 
in  the  older  countries  (assuming  equal  efficiency)  must 
also  be,  except  for  the  greater  costs  of  transporta¬ 
tion,  as  profitable  as  agriculture  in  the  new,  because  as 
profitable,  save  for  transportation  costs,  as  manufactures 
in  the  new. 

§6 


The  Infant  Industry  Argument  for  Protection 


The  argument  which  is  usually  regarded  by  economists 
as  stating  the  best  case  for  the  protective  tariff,  is  the 
so-called  infant  industry  argument.  The  more  careful 
thinkers  who  advance  this  argument  admit  that  protec¬ 
tion  involves  a  cost,  a  temporary  loss  of  productive  power. 
They  admit  that  it  involves  turning  industry  from  a 
more  productive  into  a  less  productive  line.  But  they 
urge  that  the  newly  established  line  may  be  only  tempo¬ 
rarily  less  productive  and  may  be  eventually  more  pro- 


PART  II  —  K 


i3o  ECONOMIC  ADVANTAGES  OF  COMMERCE 


ductive  and  advantageous  for  the  country  than  the 
older  lines  of  industry.  It  is  urged  that  a  country  may 
have  natural  advantages  adequate  to  the  successful 
carrying  on  of  a  given  industry,  but  that,  at  the  begin¬ 
ning,  the  competition  from  more  experienced  manage¬ 
ment  and  better  trained  workmen  abroad  is  likely  to 
prevent  the  growth  and  development  of  the  industry, 
and,  therefore,  to  prevent  the  attainment  of  the  greatest 
possible  efficiency  in  it.  Give  such  an  industry  tempo¬ 
rary  protection,  it  is  said,  so  that  it  can  get  a  start, 
and  it  may  eventually  undersell  its  foreign  rivals.  Then 
the  protectionist  country  will  perhaps  realize  a  gain  which 
will  more  than  compensate  for  the  temporary  loss.1 

It  should  be  said,  to  begin  with,  that  this  argument 
for  protection  applies  at  all,  only  in  regard  to  those 
industries  in  which  success  depends  largely  on  acquired 
skill  and  not  merely  on  natural  advantages.  It  is  hardly 
an  argument,  therefore,  in  favor  of  protection  to  much 
else  than  new  manufactures,  and  it  is  not  an  argument 
in  favor  of  perpetual  protection  for  these.  It  is  highly 
probable,  however,  that  in  some  cases,  if  the  industries 
to  be  protected  are  chosen  wisely,  and  are  not  protected 
too  long,  the  desired  results  can  be  attained.  In  the 
United  States,  a  considerable  part  of  the  silk  industry, 
started  by  protection,  seems  eventually  to  have  reached 
a  position  where  it  can  produce  as  cheaply  as  foreign 
concerns  and  where,  therefore,  it  does  not  need  pro¬ 
tection.2 

But  while  such  suggestions  have  a  great  deal  of  force, 
the  opposing  considerations,  especially  on  the  practical 

1  This  view  was  presented  in  Alexander  Hamilton’s  Report  on  Manufactures, 
and  later,  in  Germany,  was  urged  by  Friedrich  List. 

2  Mason,  “The  American  Silk  Industry  and  the  Tariff,”  American  Economic 
Association  Quarterly,  December,  1910,  p.  177. 


SPECIAL  ARGUMENTS  FOR  PROTECTION  13 1 


side,  are  also  not  without  weight.  In  the  first  place, 
though  new  industries  may  indeed  be  developed  in  this 
way,  yet  they  can  be  thus  developed  only  by  drawing  the 
labor  force  required,  from  other  lines.  It  follows  that 
the  development  of  skill  and  the  progress  of  invention 
in  those  other  fines  may  be  retarded  as  much  as  in  the 
new  fines  they  are  forwarded.  New  ideas  are  less  likely 
to  be  evolved  among  a  few  than  among  many.  And  in 
proportion  as  there  are  more  persons  in  the  new  fines,  there 
are  fewer  persons  in  the  old  fines.  Indeed,  it  is  not 
inconceivable  that  some  of  the  older  industries,  indus¬ 
tries  still  capable  of  further  progress,  may  be  made  so 
comparatively  unprofitable  —  especially  if  their  neces¬ 
sary  machinery  or  materials  are  taxed  by  the  tariff  — 
as  to  be  entirely  given  up.  We  have  already  seen  that 
protection  tends  to  decrease  the  export  trade  1  and  that 
it  may,  by  leading  to  rise  of  prices,2  ruin  other  industries.3 
Before,  then,  protection  is  accorded  to  an  infant  or  em¬ 
bryonic  or  projected  industry,  inquiry  should  be  made 
as  to  the  following  points:  first,  as  to  whether  that 
industry  can  be  expected  to  develop  without  such  aid ; 
second,  as  to  whether,  if  it  will  not,  such  aid  will  suffice 
to  develop  it  to  a  point  where  it  can  and  will  sell  its 
products  more  cheaply  than  they  can  probably  be  secured 
elsewhere,  and  enough  more  cheaply  to  compensate,  with 
interest,  for  the  loss  incident  to  starting  it ;  third,  as  to 
whether  the  attempt  to  encourage  it  might  not  involve 
a  risk  of  discouraging  other  industries,  which  would 
balance  any  hoped-for  gain. 

In  view  of  all  these  considerations,  it  becomes  impor- 


1  Chapter  IV  (of  Part  II),  §  i. 

2  Or  a  change  in  value  relations  of  money  systems,  which  acts  similarly. 

3  Chapter  IV  (of  Part  II),  §  6. 


132  ECONOMIC  ADVANTAGES  OF  COMMERCE 


tant  to  judge  the  fitness  of  the  governing  body  to  apply 
such  a  policy,  decide  upon  its  effects,  and  select  the 
industries  to  be  encouraged.1  It  is  a  special  function  of 
the  enterpriser-capitalist  to  select  for  his  own  investment 
(and  the  investments  of  those  whom  he  influences)  indus¬ 
tries  capable  of  succeeding.  If  he  does  not,  the  principal 
loss  falls  upon  him  and  upon  others  in  like  situation.  The 
community  suffers  only  indirectly  and  incidentally. 
The  enterpriser-capitalist  is  a  product  of  selection. 
His  power  to  direct  industry  into  profitable  chan¬ 
nels  is  due  to  his  possession  of  capital,  or  the  confidence 
of  other  business  men  and  investors,  or  both.  His  pos¬ 
session  of  capital  and  of  this  confidence,  though  some¬ 
times  due  in  part  to  inheritance  from  able  progenitors 
or  relatives,  is  frequently  due,  in  no  small  degree,  to  past 
successes.  He  has  the  power  to  direct  industry  into  those 
lines  which  he  believes  will  pay  best  and  which,  there¬ 
fore,  are  presumably  the  lines  most  needed  by  the  com¬ 
munity,  because  he  has  successfully  so  directed  industry 
in  the  past.  Men  whose  knowledge  of  law  or  politics 
has  made  them  members  of  a  law-making  body  are  not, 
as  a  rule,  the  product  of  the  same  kind  of  selection.  If 
they  were,  the  fact  that  their  own  fortunes  are  not  at 
stake  does  not  conduce  to  caution.  In  case  a  new 
industry  established  by  protection  never  becomes 
profitable,  the  loss  which  its  establishment  causes  falls 
upon  the  general  public  and  not  upon  legislators  as  such. 
Similarly,  in  case  an  industry  is  prematurely  established 
or  in  case  its  establishment  retards  other  industries,  the 
loss  is  that  of  the  public. 

Given  the  present  form  of  our  own  and  other  republican 

1  Cf.  Bastable,  The  Theory  of  International  Trade,  fourth  edition,  London 
(Macmillan),  1903,  p.  140. 


SPECIAL  ARGUMENTS  FOR  PROTECTION  133 


governments,  there  is  a  special  pressure  tending  towards 
unwise  selection  of  lines  to  be  favored.  This  is  the  pres¬ 
sure  of  localities  or,  at  least,  of  large  interests  in  various 
localities.  For  in  republican  government,  legislators 
usually  represent  districts,  states,  or  other  territorial 
units.  When  it  is  proposed  to  encourage  various  indus¬ 
tries,  when  the  idea  of  protection  is  politically  dominant, 
many  and  influential  interests  in  each  state  and  district 
are  likely  to  desire  that  the  industries  of  that  state  and 
district  shall  get  such  help  at  the  general  expense.  The 
tariff  eventually  decided  upon,  the  tariff  to  which  legis¬ 
lators  from  different  sections  can  agree,  is  not  likely  to 
be  one  which  even  attempts,  scientifically,  to  apply  the 
theory  of  infant  industry  protection.  Instead,  it  is 
likely  to  be  a  hodge-podge  of  special  favors,  distributed  ac¬ 
cording  to  the  relative  strength  of  conflicting  interests,  and 
bringing  general  and  long-continued  injury  to  the  public. 

The  longer  such  a  system  continues  and  the  more 
extensive  its  application,  the  greater  are  the  difficulties 
in  the  way  of  its  reform.  More  and  more  industries 
are  built  up  by  tariff  barriers,  and  their  owners  and  work¬ 
men  taught  to  rely  upon  these  barriers  for  protection 
against  foreign  rivalry.  Managerial  effort,  which  might 
otherwise  be  devoted  to  development  of  the  highest 
efficiency,  is  instead  devoted  to  the  exertion  of  political 
pressure.  Every  effort  is  made  by  numerous  interested 
persons  to  retain  and  increase  the  favors  secured.  Those 
engaged  in  the  industries  assisted  are  seldom  ready  to 
consent  to  reduction  of  the  tariff  after  a  period  of  favor¬ 
itism,  however  long,  but  endeavor,  usually,  to  keep  the 
protection  indefinitely.  Proposals  for  reduction  are 
met  by  predictions  of  dire  calamity,  and  strong  opposi¬ 
tion  to  reduction  is  thus  aroused. 


134  ECONOMIC  ADVANTAGES  OF  COMMERCE 


To  the  suggestion  that  protected  industries  might 
decline  and  die  without  protection,  the  answer  has  been 
made  that  “no  industry  will  ever  be  given  up  except  in 
order  to  take  up  a  better  one,  and  if,  under  free  trade, 
any  of  our  industries  should  perish,  it  would  only  be 
because  the  removal  of  restrictions  enabled  some  other 
industry  to  offer  so  much  better  rewards  that  labor  and 
capital  would  seek  the  latter.” 1  There  is  doubtless 
reason  in  the  contention  that,  since  many  persons  have 
invested  capital  in  the  protected  industries  and  since 
many  others  have  acquired  skill  not  equally  useful  in 
other  lines,  relying  upon  a  continuance  of  the  past  policy 
of  our  government,  therefore  the  entire  protective  system 
should  not  be  swept  away  with  one  blow.  Time  should 
be  given  (as,  under  the  tariff  reduction  policy  of  the  present 
administration  at  Washington,  it  is  being  given)  for  ad¬ 
justment  to  new  conditions.  Nevertheless,  the  public 
cannot  be  held  to  have  pledged  itself  or  to  be  under  any 
obligation  to  maintain  indefinitely  the  protective  system. 
Producers  must  be  held  to  have  taken  the  risk  of  change, 
knowing  eventual  removal  of  tariff  duties  to  be  the 
public’s  privilege.  Because  the  people  have  been  will¬ 
ing  to  pay  higher  prices  for  goods  during  a  limited 
period,  it  does  not  follow  that  they  are  duty  bound  to 
suffer  an  equivalent  annual  loss  through  all  future  time. 

§  7 

The  Argument  that  a  Protective  Policy  should  be  Fol¬ 
lowed  in  Order  to  Diversify  Industry 

It  is  also  sometimes  argued  that  protection  is  of  use 
to  diversify  industrial  activity  within  a  country.  We 


1  Sumner,  Protectionism,  p.  130. 


SPECIAL  ARGUMENTS  FOR  PROTECTION  135 


have  already  seen  that,  while  the  protective  policy 
encourages  protected  industries,  it  may  cause  the 
decline  of  others.  Yet  if  applied  carefully  and  consist¬ 
ently  with  the  object  of  diversification  in  view,  it  is 
probable  that  a  high  tariff  would  increase  the  number 
of  industries  carried  on. 

It  does  not  follow  that  prosperity  would  be  increased. 
There  is  no  special  advantage  in  having  a  larger  number 
of  occupations  carried  on  when  the  average  income  is 
reduced  by  having  them.  As  a  matter  of  fact,  a  large 
country  like  the  United  States,  with  a  wide  range  of 
natural  resources  and  a  versatile  population,  would  be 
certain  to  have  diversified  industry  within  its  borders, 
under  either  protection  or  free  trade.  With  its  mines 
of  coal,  iron,  copper,  etc.,  the  United  States  could  hardly 
fail  to  be  not  alone  an  agricultural  country,  but  a  manu¬ 
facturing  country  as  well. 

§8 

The  Argument  that  Protection  should  be  Applied  as  a 

Means  of  Getting  and  Maintaining  a  Certain  Degree  of 

National  Self-sufficiency 

Not  all  of  the  arguments  for  a  protective  tariff  are 
strictly  economic  in  character.  There  is,  for  instance, 
the  argument  that  protection  should  be  used  to  insure 
national  self-sufficiency.  This  argument,  in  so  far  as 
it  carries  great  weight,  is  of  a  military  significance.  It 
is  urged  that  a  country  at  war  with  another  or  others, 
is  likely  to  have  its  foreign  trade  seriously  interfered 
with.1  If  the  country  in  question  has  relied  on  foreign 

1  It  may,  of  course,  be  interfered  with  to  some  extent  if  another  country  or 
other  countries,  with  which  it  habitually  trades,  are  at  war.  But  only  a  part 
of  its  foreign  commerce  is  likely,  in  that  case,  to  be  affected. 


136  ECONOMIC  ADVANTAGES  OF  COMMERCE 

trade  for  the  necessaries  of  life,  it  will  be  subject  to  a 
considerable  strain  during  the  war  period,  and  perhaps 
will  be  less  able  to  carry  the  contest  to  a  successful  con¬ 
clusion.  If  it  has  relied  upon  foreign  trade  for  firearms 
and  ammunition,  it  may  be  in  no  better  position.  It  is 
asserted,  therefore,  that  a  country  should  adopt  the 
policy  of  producing  all  necessaries,  including  all  things 
required  for  war  purposes,  within  its  own  borders,  even 
though  to  do  this  brings  economic  loss. 

It  must  be  admitted  that  this  argument,  like  the  argu¬ 
ment  for  protection  to  infant  industries,  is  not  without 
claims  to  a  respectful  hearing.  There  are,  however, 
some  considerations  of  importance  on  the  other  side. 
In  the  first  place,  close  trade  relations,  such  as  are 
more  likely  to  follow  from  a  free  trade  or  from  a  low  tariff 
policy  than  from  protection,  do  much  to  promote  inter¬ 
national  good  feeling  and,  therefore,  to  prevent  the 
occurrence  of  war.  And  in  the  second  place,  even  if 
war  does  occur,  it  may  well  be  that  the  larger  wealth  and 
population  made  possible  by  a  liberal  trade  and  tariff 
policy  will  give  greater  military  strength,  through  the 
larger  fighting  force  which  can  thus  be  supported,  than 
would  any  degree  of  national  self-sufficiency.1 

In  this  connection  we  may  cite  the  case  of  Great 
Britain.  If  national  self-sufficiency  is  imperative,  there 
would  seem  to  be  nothing  which  it  would  be  more 
important  to  produce  in  the  home  country  than  food. 
Had  Great  Britain  persisted  in  a  policy  of  excluding  for¬ 
eign  grain  and  compelled  her  people  to  live  upon  what 
they  could  themselves  produce,  she  would  have  been 
aiming  at  this  ideal  of  self-sufficiency.  Had  Great 
Britain  carried  out  such  a  policy,  however,  her  population 

1  Sumner,  Protectionism ,  p.  143. 


SPECIAL  ARGUMENTS  FOR  PROTECTION  137 


could  not  have  become  so  great  by  many  millions  as  it 
has,  nor  could  her  wealth  have  become  so  great.  She 
has  chosen  rather  to  specialize  in  production,  to  import 
foodstuffs,  to  attain  a  numerous  population  and  large 
wealth.  She  is  not,  it  is  true,  self-sufficient  in  time  of 
war.  She  must  rely  for  her  food  upon  lands  across  the 
seas.  But  the  wealth  which  a  free  trade  policy  has 
brought  her  makes  possible  the  maintenance  of  the  most 
powerful  navy  in  the  world,  a  navy  by  means  of  which 
her  commerce  is  protected.  Is  England  not  a  stronger 
nation,  a  richer  nation,  and  a  not  less  independent  and 
happy  nation,  than  she  could  have  been  had  the  contrary 
policy  been  followed  ? 

§  9 

Free  Trade  within  the  United  States 

With  the  exception  of  political  or  military  arguments, 
practically  every  consideration  advanced  in  favor  of 
tariff  duties  on  goods  produced  in  foreign  countries, 
could  be  urged  with  no  less  (and  no  greater)  plausibility 
in  favor  of  tariff  duties  levied  by  one  State  or  section 
on  goods  produced  in  another  State  or  section.  Is  it 
suggested  that  we  do  not  wish  to  send  money  out  of  the 
country  and  that  to  do  so  makes  us  poorer  ?  An  exactly 
parallel  argument  would  assert  that  we  should  adopt 
measures  to  keep  money  from  being  sent  out  of  the  State 
or  the  county.  Do  stanch  protectionists  tell  us  that 
to  let  goods  come  in  from  abroad  at  low  prices,  must 
lower  American  wages  ?  If  so,  then  for  Ohio  or  Illinois 
to  let  low-priced  goods  be  imported  from  New  York  or 
from  Pennsylvania,  must  tend  to  make  wages  in  Ohio 
and  Illinois  lower  than  they  otherwise  would  be.  If 
to  shut  out  English  goods  from  the  United  States  makes 


138  ECONOMIC  ADVANTAGES  OF  COMMERCE 


additional  employment  for  American  wage  earners, 
then  to  shut  out  Connecticut  goods  from  Rhode  Island 
must  make  additional  employment  for  Rhode  Island 
wage  earners.  It  is  hardly  necessary  to  pursue  the  com¬ 
parison  further.  Carried  to  its  logical  conclusion,  the 
system  of  protection  would  prohibit  all  trade  and,  there¬ 
fore,  all  the  gain  in  wealth  which  flows  from  trade. 

Fortunately,  the  Federal  Constitution  makes  tariff 
barriers  between  the  different  states  of  the  United 
States  impossible.  If  it  did  not,  we  should  doubtless 
find  some  of  our  states  levying  protective  duties  against 
their  neighbor  states,  as  Massachusetts,  New  York,  and 
Pennsylvania  did  under  the  old  Confederation  of  1781.1 
As  it  is,  trade  between  the  states  is,  for  the  most  part, 
regarded  with  equanimity.  The  coal  of  Pennsylvania 
is  exchanged  for  the  shoes,  woolen  and  cotton  goods, 
clocks,  etc.,  of  Massachusetts,  Connecticut,  and  other 
New  England  States.  The  wheat,  corn,  and  meat  of 
the  Middle  West,  and  the  cotton,  rice,  and  sugar  of  the 
South,  are  sold  throughout  the  country,  and  the  special 
products  of  other  sections  are  given  in  payment.  When 
improvements  in  transportation  facilities  make  low 
transportation  rates  possible,  we  regard  the  consequent 
reductions  as  cause  for  rejoicing,  because  of  the  stimulus 
thus  given  to  trade.  There  is  no  reasonable  doubt  that 
free  trade  within  the  borders  of  the  United  States  adds 
greatly  to  our  national  prosperity  and  adds,  also,  to  the 
prosperity  of  each  separate  state.  To  widen  this  free 
trade  area,  so  far  as  lies  within  our  power,  would  still 
further  increase  our  economic  welfare. 

1  Hart,  Essentials  in  American  History,  New  York  (American  Book  Co.), 
1905,  P-  199- 


SPECIAL  ARGUMENTS  FOR  PROTECTION  139 

§  10 

Ethical  Considerations  Bearing  on  the  Policy  of  Protection 

Before  concluding  this  discussion  of  the  high  tariff 
system,  let  us  consider  briefly  the  moral  issues  involved. 
The  maintenance  of  this  system  means  that  wealth  is 
to  be  gained,  in  the  favored  industries,  not  by  serving 
the  public  well,  not  by  giving  to  the  public  better  goods 
than  could  otherwise  be  secured  or  goods  at  lower  prices 
than  must  otherwise  be  paid,  but  by  depriving  the 
public,  through  influence  on  legislation,  of  such  benefits. 
The  maintenance  of  protection  means  that  political 
influence  calculated  to  injure  the  community  will  often 
bring  larger  returns  to  those  who  wield  it  than  would 
business  carried  on  in  rivalry  with  others  for  the  benefit 
of  the  community.  As  a  consequence,  energies  which 
might  be  devoted  wholly  to  legitimate  business,  that  is, 
to  seeking  profit  through  efficient  service,  spend  them¬ 
selves  instead  in  selfish  political  activity,  in  the  attempt 
to  make  impossible  any  rivalry  in  service  from  foreign 
producers,  in  the  attempt  to  force  higher  prices  from  con¬ 
sumers,  and  so  to  realize,  at  the  expense  of  consumers, 
higher  profits  than  are  earned.  If  the  ideal  of  industrial 
morality  is  that  profit  shall  be  in  proportion  to  service, 
if  to  seek  profit  by  disservice  is  immoral,  then  the  selfish 
attempt  of  private  interests  to  realize  wealth  by  arbi¬ 
trarily  shutting  out  foreign  competitors  through  tariff 
restrictions,  like  the  attempt  to  shut  out  domestic 
competitors  through  seeking  railroad  discriminations, 
violates  this  ideal  and  is  immoral. 


140  ECONOMIC  ADVANTAGES  OF  COMMERCE 

§  ii 

Summary 

In  this  chapter  the  attempt  has  been  made  properly 
to  estimate  the  value  of  most  of  the  standard  arguments 
for  protection.  The  argument  that  protection  increases 
national  prosperity  by  getting  and  keeping  more  money 
in  circulation  in  the  protectionist  country  was  shown 
to  be  fallacious,  since  money  is  not  the  ultimate  or  prin¬ 
cipal  end  of  trade.  The  popular  “wages  argument”  for 
protection,  so  much  used  in  political  campaigns,  was 
shown  to  have  little  better  basis.  Money  wages  tend 
to  be  somewhat  higher  because  of  the  tariff,1  but  real 
wages  are  almost  necessarily  lower.  The  much  feared 
“competition  of  cheap  foreign  labor”  is  beneficial  to 
our  wage  earners  when  it  means  cheap  goods  from  abroad, 
and  is  injurious  to  our  wage  earners  only  when  it  means 
immigration  of  this  cheap  labor.  Those  who  attempt 
to  show,  inductively,  e.g.  by  comparison  of  English  and 
American  wages,  that  protection  makes  wages  higher, 
fail  to  take  other  things,  such  as  relative  density  of 
population,  into  account.  The  argument  that  pro¬ 
tection  increases  the  opportunities  for  employment  was 
likewise  shown  to  be  untenable.  It  increases  employ¬ 
ment  in  any  industry  only  by  making  that  industry  more 
profitable.  But  in  so  doing  it  makes  other  industries 
less  profitable.  Natural  resources  and  accumulated 
capital,  which  make  employment  at  remunerative 
wages  possible,  are  not  increased  by  protective  tariffs. 

The  third  argument  considered  was  the  so-called 
“  home  market”  argument.  This  is  one  of  the  principal 

1  Except,  o!  course,  in  the  case  of  unrelated  currencies.  See  Ch.  V  (of  Part 

II),  §  3. 


SPECIAL  ARGUMENTS  FOR  PROTECTION  141 


arguments  by  which  the  farmers’  votes  are  sought  for 
the  protective  policy.  Examination  showed  that  the 
gaining  of  a  home  market  by  protection  involves  the 
losing  of  a  foreign  market  in  whole  or  in  part,  and  that 
the  higher  prices  which  protection  makes  farmers  pay  for 
goods  are  not  compensated  for  by  the  fact,  supposing  it 
to  be  a  fact,  that  those  to  whom  the  money  is  paid  have 
more  money  with  which  to  buy  farm  produce. 

An  argument  having,  if  convincing,  more  significance 
at  present  for  Europeans  than  for  Americans,  is  that  in 
favor  of  protection  to  agriculture,  as  security  against 
a  time  when  the  newer  countries  may  be  less  inclined 
to  buy  manufactured  goods  of  and  sell  food-stuff s,  etc., 
to  the  older  ones.  We  saw,  however,  that  if  future  trade 
is  unimpeded  or  is  impeded  only  by  low  tariffs,  the 
older  countries  can  always  have  a  market  for  their  manu¬ 
factures  without  having  to  accept  returns  less  by  much 
more  than  necessary  transportation  costs,  than  those  of 
manufacturing  industries,  and,  therefore,  agriculture, 
in  the  more  largely  agricultural  countries.  Unless  great 
restrictions  on  future  trade  are  feared,  this  argument  for 
protection  to  agriculture  has  little  force. 

Protection  to  infant  industries  has  been  urged,  even 
by  some  careful  thinkers,  as  a  desirable  temporary  policy. 
The  principal  objections  are  practical.  It  is  difficult 
to  be  certain  that  the  development  of  other  industries 
is  not  being  hindered  as  much  as  that  of  the  favored  in¬ 
dustry  is  being  helped.  It  is  difficult  to  be  certain  that 
the  protected  industry  will  eventually  reach  a  point  of 
development  such  that  the  cheapness  of  its  products  will 
repay  the  public  for  the  admitted  temporary  loss.  It  is 
doubtful  if  a  legislative  body  is  usually  competent  to 
select  industries  for  protection,  on  this  principle,  and  it 


i42  ECONOMIC  ADVANTAGES  OF  COMMERCE 


is  probable  that,  in  practice,  political  pressure  from 
interested  parties  in  various  localities  will  play  much  too 
great  a  part.  There  is  danger  that  the  temporary  pro¬ 
tection  will  be  continued  much  longer  than  is  necessary 
or  desirable,  since  its  beneficiaries  seldom  want  to  give 
it  up. 

Protection  is  also  urged  as  a  means  of  diversifying 
industry,  and  it  probably  has  somewhat  this  effect.  Yet 
diversification  can  be  purchased  at  too  great  a  cost. 
And  a  large  country,  with  varied  resources,  is  pretty 
sure  of  a  considerable  diversity  of  industry,  even  without 
protection. 

The  argument  for  protection  to  insure  national  self- 
sufficiency  is,  in  the  main,  a  military  argument.  Na¬ 
tional  self-sufficiency  is  undoubtedly  an  advantage  in 
time  of  war.  So  is  large  population  and  great  wealth. 
Protection  tends  to  increase  the  degree  of  self-sufficiency 
and  to  limit  wealth  and  (consequently)  population.  It 
cannot  be  definitely  asserted,  therefore,  that  protec¬ 
tion  has  often  an  adequate  military  justification.  The 
greater  wealth  and  population  resulting  from  a  free  trade 
policy  may  mean  the  possibility  of  a  larger  army  and 
navy  and  a  greater  safety  from  attack. 

Most  of  the  arguments  for  protective  tariffs  on  foreign 
produced  goods  (though  not,  of  course,  the  military  argu¬ 
ment)  might  be  used  with  equal  plausibility  in  favor  of 
protection  by  one  part  of  a  country  against  goods  pro¬ 
duced  in  another  part.  It  is  generally  taken  for  granted, 
however,  at  least  in  the  United  States,  that  free  intra¬ 
national  trade  brings  benefit  to  each  separate  state  or 
other  section  of  the  country.  If  so,  free  trade  with  for¬ 
eign  countries  would,  in  the  same  way,  bring  gain  to  the 
nation  as  a  whole. 


SPECIAL  ARGUMENTS  FOR  PROTECTION  143 


The  industrial  and  commercial  ideal  is  that  wealth 
shall  be  gained  by  service  to  the  community  and  not  by 
injuring  the  community.  Tested  by  this  ideal,  the  effort 
of  interested  parties  to  get  protection  for  their  industries 
is  morally  wrong.  For  they  are  endeavoring  to  gain  busi¬ 
ness  and  wealth  by  prohibiting  a  foreign  competition 
beneficial  to  the  public,  instead  of  by  serving  the  public 
better  than  do  their  foreign  rivals. 


CHAPTER  VII 


The  Nature  and  Effects  of  Bounties 


Bounties  as  Compared  and  Contrasted  with  Protection 

Somewhat  similar  in  principle  to  an  import  protective 
tariff  is  a  bounty.  A  bounty  is  a  payment  made  at 
intervals  by  government  to  the  persons  engaged  in  some 
industry  which  it  is  desired  to  encourage,  in  proportion 
to  the  quantity  of  goods  turned  out  or  sold  or  in  proportion 
to  the  quantity  exported.  The  purpose  is,  or  purports 
to  be,  the  encouragement  and  development  of  the  industry 
receiving  the  periodic  payment.  A  bounty  is  like  pro¬ 
tection  in  that  it  tends  to  divert  industrial  activity  into 
a  different  line  or  lines  than  such  activity  would  other¬ 
wise  follow.  Thus,  to  use  our  previous  illustration, 
Canada  could,  by  means  of  a  bounty  as  well  as  by  pro¬ 
tection,  encourage  Canadian  production  of  linen.  The 
beet  sugar  industry  in  continental  Europe  has  been, 
largely,  so  encouraged.  Likewise,  by  means  of  bounties 
or  so-called  shipping  subsidies,  a  number  of  countries 
have  endeavored  to  build  up  their  shipping  interests.1 

On  the  other  hand,  the  bounty  differs  in  several  re¬ 
spects,  in  its  application,  from  protection.  To  begin 
with,  a  protective  tariff  encourages  an  industry  by  guar¬ 
anteeing  it  the  home  market,  i.e.  by  shutting  out  goods 
from  abroad.  But  a  bounty  does  not  attempt  to  inter- 

1  See  discussion  of  shipping  subsidies  in  Ch.  VIII  (of  Part  II),  §  2. 

144 


THE  NATURE  AND  EFFECTS  OF  BOUNTIES  145 


fere  with  foreign  competition.  It  endeavors,  rather, 
to  enable  the  home  producer  more  easily  to  meet  foreign 
competition.1  The  one  method,  protection,  directly 
shuts  out  rivals.  The  other  method  provides  home 
producers  with  the  means  to  drive  out  rivals. 

It  follows,  as  a  second  and  related  distinction,  that, 
while  a  protective  tariff  enables  the  protected  producers 
to  charge  more  for  their  goods,  a  bounty  puts  the  favored 
producers  in  a  position  to  sell  their  goods  for  less  than 
they  could  otherwise  afford  to  take.2  It  is  thus  that 
these  producers  are  enabled  to  capture  the  business. 
A  bounty  may,  because  of  this  difference  from  protec¬ 
tion,  divert  industry  out  of  its  natural  channels  to  a 
greater  degree  than  a  protective  duty.  For  the  latter 
can  do  no  more  than  guarantee  the  home  market  to  pro¬ 
ducers  who,  since  they  need  protection  at  home,  are 
unlikely  to  get  any  considerable  business  elsewhere; 
and  in  fact,  protection,  by  causing  inflow  of  money  and 
higher  money  costs,  is  likely  to  have  the  effect  of  making 
invasion  of  foreign  markets  more  difficult  than  before. 
But  the  former,  a  bounty,  may  make  it  possible  for  an 
industry,  through  competition  in  lower  prices,  to  capture 
the  markets  of  the  world,  though  very  probably  at  great 
expense  to  the  taxpayers  of  the  bounty-paying  country. 

Third,  the  burden  of  protection  falls  upon  the  buyers 
of  protected  goods  in  proportion  to  their  purchases  of 
these  goods;  while  the  burden  of  a  bounty  falls  upon 
taxpayers  in  proportion  to  their  respective  contributions 
to  the  tax  fund.  Protection  compels  consumers  to  pay 
higher  prices.  A  bounty  compels  citizens  to  pay  higher 
taxes. 

1  Cf.  R.  Meeker,  History  of  Shipping  Subsidies  (in  Publications  of  the  Ameri¬ 
can  Economic  Association,  August,  1905),  p.  172. 

*  Cf.  ibid.,  p.  173- 

PART  II  —  L 


146  economic  advantages  of  commerce 

§2 

The  Various  Possible  Effects  of  Bounties  on  the  Level  of 

Prices 

The  effect  of  a  bounty  on  the  general  level  of  money 
prices  in  the  bounty-paying  country  is  similar  to  that 
of  protection.  We  may,  for  the  purposes  of  our  discus¬ 
sion,  distinguish  three  cases.  In  the  first  case,  the 
bounty  acts  like  a  protective  tariff  in  that  it  decreases 
imports.  Thus,  Canada  might  have  a  bounty  of  43 
cents  a  yard  or  slightly  more,  on  linen  cloth,  which  would 
enable  the  Canadian  cloth  producers  to  sell  at  home  for 
$1  or  slightly  less  a  yard,  instead  of  $1.43.  As  a  conse¬ 
quence,  we  may  suppose,  the  Canadian  cloth  producers 
would  be  able  to  get  complete  control  of  the  home  market. 
Then,  as  in  the  case  of  protection,  no  money  would  flow 
to  Ireland  or  elsewhere,  for  linen.  But  foreign  con¬ 
sumers  would  still  buy  Canadian  wheat,  and  there  would 
be  a  tendency  for  prices  in  general,  in  Canada,  including 
the  price  of  linen,  to  rise.1  Eventually  Canadian  prices 
would  be  enough  higher  than  before,  as  compared  with 
foreign  prices,  to  bring  back  equilibrium  in  trade.  If 
Canada’s  currency  system  were  unrelated  to  the  systems 
of  other  countries,  if,  for  example,  it  were  based  on  incon¬ 
vertible  paper,  the  rise  of  money  prices  would  not  take 
place,  but  equilibrium  of  trade  would  eventually  result 
through  a  change  in  the  relative  values  of  Canadian  and 
other  currencies.2 

In  the  above  assumed  case,  we  have  supposed  a  bounty 
not  quite  high  enough  to  make  it  easy  or  perhaps  possible, 

1  This  might  lead,  as  in  the  case  of  protection,  to  a  demand  for  a  greater 
bounty,  or  to  a  demand  for  bounties  to  industries  previously  not  encouraged. 
See  Ch.  IV  (of  Part  II),  §  6. 

*  See  Part  I,  Ch.  VI,  §§  6,  7,  8,  9,  and  Part  II,  Ch.  IV,  §  3. 


THE  NATURE  AND  EFFECTS  OF  BOUNTIES  147 


for  Canadian  linen  producers  to  meet  transportation  costs 
and  invade  foreign  markets.  Let  us  now  suppose  a 
bounty  of  60  cents  a  yard.  With  a  production  cost  of 
$1.43,  this  bounty  would  reduce  the  net  cost  to  83  cents 
a  yard.  Even  after  paying  transportation  costs,  Cana¬ 
dians  could  then  perhaps  sell  linen  abroad  for  85  or  90 
cents  a  yard,  thus  greatly  increasing  their  business  and 
driving  out  foreign  competitors.  In  this  case,  not  only 
would  Canadian  importation  of  linen  be  decreased,  but 
Canadian  exportation  of  linen  would  be  greatly  increased. 
As  a  consequence,  there  would  be  a  net  inflow  of  money 
into  Canada  and  a  relative  rise  of  Canadian  prices.  This 
rise  would  continue  until  equilibrium  became  estab¬ 
lished  either  by  larger  purchases  of  Canadians  abroad, 
or  by  smaller  purchases  of  foreigners  in  Canada,  or  by 
both.  Thus,  Canadians  might  even,  if  prices  should 
rise  sufficiently,  buy  goods  abroad  which  they  had  pre¬ 
viously  produced  at  home.  If  so,  other  Canadian  pro¬ 
ducers  would  clamor  for  bounties  or  for  protection. 
Nevertheless,  an  equilibrium  of  trade  must  eventually  be 
established.1 

The  third  case  would  be  realized  if,  at  the  time  of  es¬ 
tablishing  a  bounty  on  linen  manufacture,  Canada  was 
already  largely  supplying  the  world  with  linen  and  could 
not  hope  greatly  to  extend  her  foreign  market.  In  this 
case,  the  effect  of  the  bounty  (assuming  free  competition 
among  present  and  potential  Canadian  linen  producers) 
would  be  to  lower  the  price  of  linen  without  correspond¬ 
ingly  increasing  its  sale.  Less  money  would  therefore 
flow  into  Canada,  while  as  much  as  before  would  flow 
out.  Other  things  equal,  there  would  be  a  net  outflow 
of  money,  and  money  prices  would  fall.  It  hardly  needs 

1  Cf.  Ch.  IV  (of  Part  II),  §  6. 


148  ECONOMIC  ADVANTAGES  OF  COMMERCE 


to  be  stated  that,  if  Canada’s  money  system  is  assumed 
to  be  different  from  those  of  other  countries,  there  would 
be  a  change  in  the  value  of  Canadian  money  in  terms  of 
other  money,  rather  than  a  fall  in  Canadian  prices.1 

§  3 

The  Various  Possible  Effects  of  Bounties  on  the  General 
Welfare  in  the  Bounty-paying  Country  and  in  the 
Countries  with  which  it  Trades 

Consideration  of  the  effects  of  a  bounty  on  the  general 
welfare  of  the  bounty-paying  country  and  of  the  countries 
with  which  it  trades,  may  profitably  follow  the  line  of 
the  above  three  cases.  In  the  first  case,  where  it  decreases 
imports  by  enabling  the  home  producers  to  gain  the  home 
market  but  does  not  enable  them  to  gain  a  foreign 
market,  the  bounty  acts  substantially  like  a  protective 
tariff.  It  tends  to  prevent  imports  but  not  to  stimulate 
exports.  It  conduces  to  national  self-sufficiency.  It 
prevents  what  would  else  be  a  profitable  trade.  Like 
protection,  it  turns  labor  and  capital  away  from  the  chan¬ 
nels  they  would  naturally  follow,  away  from  what  are 
presumably  the  most  profitable  channels,  into  channels 
favored  by  law.  The  effects  on  total  production  are 
obviously  the  same,  whether  diversion  is  caused  by  pro¬ 
tection  or  by  bounty. 

Not  only  is  the  bounty-paying  country  injured,  but 
also  the  countries  with  which  it  trades  are,  presumably, 
to  some  extent  injured.  These  other  countries  lose  a 
profitable  export  trade,  and  they  do  not  secure  goods 
more  cheaply  from  the  bounty-paying  country  since  the 
bounty  is  not  high  enough,  in  the  first  case  discussed, 

1  See,  particularly,  Part  I,  Ch.  VI,  §§  6,  7,  8. 


THE  NATURE  AND  EFFECTS  OF  BOUNTIES  149 


to  encourage  sales  abroad  by  the  recipients  of  this 
bounty. 

The  second  case  to  be  considered  is  that  in  which  the 
bounty  encourages  export  by  the  bounty-paying  country, 
of  the  goods  on  which  the  bounty  is  paid.  If  desired, 
the  bounty  may  be  paid  only  on  exported  goods.  In 
this  second  case,  as  in  the  first,  the  prosperity  of  the 
bounty-paying  country  is  made  less  than  it  otherwise 
might  be.  Industry  is  turned  from  more  profitable 
into  less  profitable  channels.  Trade  with  other  coun¬ 
tries  is  not  prevented  to  the  extent  that  it  is  in  the  first 
case  or  in  the  case  of  protection,  and  may  be  actually 
increased.  But  the  trade  stimulated  is  not  relatively  a 
profitable  trade.  The  export  of  linen  by  Canada,  in 
our  illustration,  takes  the  place  of  other  exportation  more 
profitable  to  Canada  or  of  internal  trade  which  would 
be  more  profitable.  It  is  as  uneconomical  to  encourage 
a  trade  which  would  not  otherwise  take  place,  as  to  dis¬ 
courage,  by  protection  (or  by  high  export  taxes),  trade 
which  otherwise  would  take  place. 

The  effect  of  the  bounty  on  other  countries  than  the 
one  which  pays  it,  is,  in  this  second  case,  beneficial. 
We  know  that  other  countries  would  gain  by  the  trade 
if  the  new  industry  were  one  which  became  established 
in  the  bounty-paying  country  because  of  suddenly  dis¬ 
covered  natural  resources  or  because  of  acquisition  of 
skill.  And  as  far  as  other  countries  are  concerned, 
the  bounty  has  the  same  effect  as  either  of  these  other 
causes  of  development  of  the  favored  industry.  It  is 
no  longer  desirable  for  them  to  produce  the  goods  in 
question  for  themselves.  These  goods  can  be  got  more 
cheaply  at  the  expense  of  the  taxpayers  of  the  bounty¬ 
paying  country.  The  persons  in  other  countries,  who 


i5o  ECONOMIC  ADVANTAGES  OF  COMMERCE 


formerly  produced  these  goods,  must,  it  is  true,  change 
their  occupation.1  But  there  are  presumably  other 
occupations  equally  or  almost  equally,  profitable,  and  the 
consumers  of  these  other  countries  gain,  therefore,  more 
than  the  producers  lose.2 

In  the  third  case,  the  bounty  does  not  appreciably 
increase  the  sales  abroad  by  the  favored  producers  of  the 
bounty-paying  country,  but  simply  results  in  their  selling 
about  the  same  quantity  of  their  goods  at  lower  prices. 
In  this  case,  the  loss  to  the  bounty-paying  country  is 
more  obvious  than  in  the  other  cases,  while  it  is  even 
clearer  than  in  the  second  case,  that  foreign  countries 
gain.  Since  the  bounty  simply  lowers  prices  without 
extending  trade,  it  benefits  foreign  consumers  without 
driving  any  foreign  producers  from  the  line  of  produc¬ 
tion  favored  into  other  lines.3 


1  The  trade  between  second  and  third  countries  and  their  relative  gains  from 
trade,  may  be  affected.  A  bounty  on  the  production  of  linen  in  Canada  may, 
by  encouraging  export  of  Canadian  linen,  drive  Irish  manufacturers  out  of,  say, 
the  German  market.  Irish  linen  producers  are  injured.  German  linen  con¬ 
sumers  are  benefited.  But  Ireland  can  get  its  own  linen,  thereafter,  more 
cheaply  by  importing  it  from  Canada,  and  gains  in  so  far  as  linen  is  desired  to 
use.  Ireland  is  injured  in  so  far  as  Canada  enters  trade  as  her  competitor  in 
selling  linen  to  Germany,  but  this  loss  is  balanced  by  Germany’s  gain.  Ireland 
gains  in  so  far  as  she  secures  linen  from  abroad  more  cheaply  than  she  could 
make  it  herself.  It  becomes  more  economical  for  Ireland  to  devote  herself  to 
some  other  line  or  lines.  If  the  new  products  which  she  now  endeavors  to  ex¬ 
port  are  less  desired  abroad  than  the  old,  the  rate  of  trade  will  tend  to  become 
somewhat  less  favorable  to  Ireland  and  more  favorable  to  these  other  countries, 
than  before.  Ch.  II  (of  Part  II),  §  2.  Ireland  will  also,  probably,  become  some¬ 
what  more  self-sufficient.  But  the  conclusion  remains  that  when  all  other  countries 
except  the  bounty-paying  country  are  considered,  the  general  result  is  favorable. 
See,  however,  Ch.  IV  (of  Part  II),  §  6. 

2  See  Ch.  IV  (of  Part  II),  §  2. 

3  There  is  a  tendency,  also,  for  the  rate  of  trade  to  become  more  favorable 
to  other  countries  and  less  so  to  the  bounty-paying  country.  Money  flows  out 
of  the  latter  and  into  the  former.  Prices  fall,  relatively,  in  the  latter  and  rise, 
relatively,  in  the  former,  though  this  change  would  probably  be  slight  in  the 
case  of  a  bounty  on  only  one  kind  of  goods.  Hence,  foreign  countries  may  be 


THE  NATURE  AND  EFFECTS  OF  BOUNTIES  15 1 


England  was  for  a  long  time  a  very  great  gainer  by 
virtue  of  the  export  bounties  paid  on  beet  sugar  until 
1903,1  by  the  beet  sugar  producing  countries  of  conti¬ 
nental  Europe. 

Had  only  one  such  country  adopted  a  bounty-paying 
policy,  the  effect  would  have  been  much  larger  exports 
of  sugar  for  that  country  and  a  slightly  lower  price  of 
sugar  for  buying  countries.  This  is  the  kind  of  situation 
discussed  in  our  second  case.  But  when  all  the  Euro¬ 
pean  beet  sugar  countries  were  simultaneously  paying 
bounties  on  exported  sugar,  the  net  result  was  that  no  one 
of  them  could  extend  its  export  trade  to  anything  like 
so  great  a  degree,  while  all  of  them  had  to  accept  very 
low  prices  for  their  product.  There  was  then  a  closer 
approximation  to  the  conditions  described  in  our  third 
case,  though  probably,  since  beet  sugar  largely  displaced 
cane  sugar  from  the  West  Indies  and  elsewhere,  the  con¬ 
ditions  of  case  3  were  not  realized. 

However  this  may  have  been,  it  is  obvious  that  the 
sugar  consumers  of  other  parts  of  the  world  were  great 
gainers  by  virtue  of  these  bounties,  and  gainers  at  the 
expense  of  the  bounty-paying  countries.  Particularly 
did  the  bounties  redound  to  the  profit  of  free-trade 
England,  whose  people  were  not  prevented  by  tariff 
restrictions  from  securing  the  sugar  cheaply.2  So  it 
resulted  that  the  English  were  able  to  consume  several 
times  as  much  sugar  per  capita  as,  for  instance,  the 

able  to  buy  other  goods  than  the  favored  kind  more  cheaply  than  before  from 
the  bounty-paying  country,  while  having  higher  money  incomes  with  which  to 
buy. 

1  Fisk,  International  Commercial  Policies,  New  York  (Macmillan),  1907,  p. 
137- 

2  Although  eventually,  because  of  colonial  sugar  interests  in  the  West  Indies, 
England  supported  the  general  agreement  to  discontinue  the  bounty  competi¬ 
tion.  It  does  not  follow,  of  course,  that  England  acted  wisely  in  so  doing. 


152  ECONOMIC  ADVANTAGES  OF  COMMERCE 


bounty-paying  Germans.1  Furthermore,  all  those  Brit¬ 
ish  industries  which  depended  upon  the  use  of  sugar 
prospered  in  a  large  degree.2  In  the  confectionery  and 
preserving  trades,  thousands  of  persons  were  employed 
and  many  thousands  of  tons  of  sugar  were  annually  used. 

If,  in  some  distant  future,  the  philosophy  of  protec¬ 
tionism  comes  ever  upon  the  discredit  which  it  deserves, 
the  descendants  of  those  whose  taxes  supported  the 
favored  business  of  sugar  production  may  at  least  con¬ 
sole  themselves  with  the  thought  that  many  foreigners 
were  benefited.  Though  the  bounties  turned  industry 
from  its  natural  channels,  though  they  caused  the  con¬ 
sumption  of  beet  sugar,  when  cane  sugar  would  have 
involved  a  less  labor  cost,  though  they  diminished  the 
economic  well-being  of  the  world  as  a  whole,  though 
part  of  the  taxpayers’  burdens  was  therefore  in  every 
sense  a  net  loss ;  yet  another  part  of  their  burdens  was 
compensated  for  by  extra  gains,  in  the  form  of  cheaper 
sugar,  to  the  people  of  a  neighbor  nation. 

§4 

The  Various  Possible  Effects  of  Bounties  on  Wages  and  Rent 

A  bounty,  or  system  of  bounties,  would  usually  affect 
money  wages  as  compared  with  real  wages,  just  as  does 
a  protective  tariff.  The  immediate  effect  of  a  bounty 
would  be  to  tax  the  people  more  than  it  lowered  the 
price  of  the  goods  favored.  For  illustration,  suppose 
that  Canada  can  buy  linen,  in  Ireland,  for  $i  a  yard, 
while  the  cost  of  linen  produced  in  Canada  is  $1.43. 
By  granting  a  bounty  of  43  cents  or  of  53  cents,  the 

1  Sumner,  Protectionism,  New  York  (Holt),  1885,  p.  81. 
s  Ibid.,  p.  86. 


THE  NATURE  AND  EFFECTS  OF  BOUNTIES  153 


Canadian  government  enables  home  manufacturers  to 
sell  linen  at  $1  or  at  90  cents  a  yard.  The  people  of 
Canada  lose,  as  taxpayers,  43  cents  to  gain  nothing,  or 
53  cents  to  gain  10  cents.  Unless  the  taxes  are  so  levied 
that  they  do  not  fall  upon  and  cannot  be  shifted  to  wage 
earners,1  real  wages  must  be  lower.2  This  remains 
true  after  the  inflow  of  money  which  raises  prices  (or  the 
outflow  —  case  3  —  which  lowers  prices).  For  money 
prices  and  money  wages  will  tend  to  be  affected  in  equal 
proportion  by  the  change  in  money  supply.  A  bounty 
on  exports  only,  may  lower  the  price  of  the  favored  goods, 
to  foreign  consumers,  at  the  expense  of  taxpaying 
citizens  of  the  bounty-giving  country,  while  it  will  not 
lower  the  price  to  domestic  consumers. 

§5 

Why  Bounties  may  he  Less  Objectionable  than  Protection 
if  Encouragement  of  Infant  Industries  is  in  Any  Case 
to  be  Attempted 

The  bounty  method  has  sometimes  been  recommended 
as  superior  to  the  method  of  protection,  for  the  estab¬ 
lishing  and  developing  of  an  infant  industry.  Since  the 
bounty  system  is  more  clearly  seen  to  involve  taxation, 
public  support  is  less  likely  to  be  given  to  schemes  for 
its  widespread  application.  It  is  perhaps  not  quite  so 
unlikely  that  care  will  be  used  in  deciding  upon  the 
industry  or  industries  to  be  favored.  For  the  same  rea¬ 
son,  the  likelihood  that  the  bounty  will  remain  a  perma¬ 
nent  burden  upon  the  general  public  may  be  somewhat  less. 

1  Even  if  the  necessary  taxes  fall  in  no  sense  upon  wage  earners,  and  so  really 
raise  wages,  they  raise  wages  less  by  turning  labor  into  unprofitable  lines  than 
if  the  money  were  directly  paid  to  wage  earners1,  as  a  forced  charity. 

*  There  is,  however,  as  with  protection,  a  conceivable  exceptional  case.  Cf. 

Ch.  V  (of  Part  II),  §  5. 


154  ECONOMIC  ADVANTAGES  OF  COMMERCE 

§6 

Summary 

A  bounty,  like  protection,  is  a  special  favor  granted 
by  government  to  some  industry  or  industries.  It 
differs  from  protection  in  that  it  does  not  tax  foreign 
competition,  but  enables  the  domestic  producer  to  meet 
it,  in  that  it  lowers  instead  of  raises  the  price  of  the 
favored  goods,  and  in  that  the  burden  falls  upon  tax¬ 
payers  as  such  rather  than  upon  consumers.  A  bounty 
may  simply  insure  domestic  producers  their  home  mar¬ 
ket,  or  it  may  be  high  enough  to  enable  them  to  meet 
transportation  costs  and  increase  their  foreign  business, 
or  it  may  enable  them  to  sell  the  same  amount  of  goods 
abroad  as  before,  at  lower  prices.  In  the  first  two  cases, 
the  level  of  prices  in  the  bounty-paying  country  will 
rise  as  compared  with  the  levels  in  the  countries  with 
which  it  trades.  In  the  third  case,  the  level  of  prices  in 
the  bounty-paying  country  will  fall.  In  all  three  cases, 
the  effect  on  the  national  prosperity  of  the  bounty-pay¬ 
ing  country  will  almost  certainly  be  unfavorable.  In  the 
second  and  third  cases,  other  countries  will  be  likely  to 
profit  to  some  extent  at  the  expense  of  the  taxpayers  in 
the  bounty-paying  country.  Since  a  bounty  system 
tends  to  burden  the  taxpayers,  with  no  corresponding 
gain  to  the  general  public,  it  tends  to  lower  real  wages, 
for  it  can  hardly  be  supposed  that  wage  earners  will  be 
unaffected  by  the  level  of  taxation.  If  an  infant  indus¬ 
try  is  in  any  case  to  be  established,  however,  the  bounty 
method  may  be  better  than  the  method  of  protection. 


CHAPTER  VIII 


Uneconomical  Government  Interference  with,  and 
Encouragement  of,  Transportation 


Navigation  Laws 


One  of  the  important  methods  which  governments 
have  sometimes  followed  in  order  to  develop  a  national 
mercantile  marine,  has  been  the  method  of  navigation 
acts,  excluding  foreign  vessels  from  certain  designated 
commerce.  For  example,  England’s  navigation  acts 
of  1646  to  1660  (act  of  1651  perhaps  of  chief  importance), 
prohibited  the  importation  of  any  goods  into  England  or 
Ireland  or  any  of  the  British  Colonies,  except  in  British 
ships,  owned  and  navigated  by  British  subjects,  or  in 
ships  of  the  country  where  the  goods  were  produced ; 
also  these  laws  prohibited  the  export  to  foreign  ports  of 
any  goods  produced  in  the  American  colonies,  except 
in  British  ships.1  Our  own  Federal  law  regarding  the 
coasting  trade  is  of  the  same  genus.  This  law  requires 
that  “no  merchandise  shall  be  transported  by  water, 
under  penalty  of  forfeiture  thereof,  from  one  port  of  the 
United  States  to  another  port  of  the  United  States, 
either  directly  or  via  a  foreign  port,  or  for  any  part  of  the 
voyage ,  in  any  other  vessel  than  a  vessel  of  the  United 
States.”  2 

1  See  Lindsay,  History  of  Merchant  Shipping,  London  (Low,  Low  and  Searle), 
1847,  Vol.  II,  pp.  182-189. 

2  30  Stat.  L.  ch.  26,  p.  248.  Referred  to  in  the  Report  of  the  Commis¬ 
sioner  of  Corporations,  on  Transportation  by  Water  in  the  United  States,  Part 


156  ECONOMIC  ADVANTAGES  OF  COMMERCE 


Such  navigation  acts  are  closely  analogous  to  protec¬ 
tive  tariffs.  Like  protection,  they  develop  the  favored 
home  industry  by  excluding  foreign  competition,  not, 
as  in  the  case  of  the  bounty,  by  providing  funds  to  help 
meet  this  competition.  Like  protection,  these  laws  can 
do  no  more  than  guarantee  home  patronage;  they  can 
not  insure  successful  invasions  of  other  commerce,  de¬ 
pendent  solely  on  foreign  patronage.  As  with  protec¬ 
tion,  the  burden  of  these  laws  rests  upon  consumers  (of 
goods  carried  in  the  protected  ships),  rather  than  upon 
taxpayers  as  such.  The  burden  rests  upon  consumers, 
because  the  exclusion  from  the  designated  commerce, 
of  ships  presumably  able  to  carry  goods  more  cheaply 
than  the  favored  domestic  ships,1  tends  towards  high 
transportation  rates,  and,  therefore,  towards  higher  prices 
to  consumers,  of  goods  carried,  or  towards  decrease  of 
domestic  commerce,  or  both.  The  burden  of  such  a 
policy  may  not  be  equally  distributed  over  a  country 
enforcing  it,  but  may  rest  with  especial  weight  upon  those 
sections  of  the  country  which,  being  on  or  near  the  coast 
line,  have  most  to  gain  from  cheap  water  transportation. 
A  navigation  policy  like  that  established  by  the  historic 
navigation  laws  of  England,  above  mentioned,  may  also 
tend,  by  increasing  transportation  costs,  to  limit  the 
export  trade  of  the  country  adopting  such  a  policy.  Only 
in  case  other  countries  have  no  available  alternative 
source  of  supply  for  goods  desired,  can  the  extra  cost  of 

I,  1909,  pp.  1 18,  1 19.  Since  the  above  was  written,  Congress  has  passed  a  law 
(August,  1914)  admitting  foreign-built  ships  to  American  registry  if  owned  or 
purchased  by  Americans  (See  New  York  World,  Aug.  18,  1914).  Such  ves¬ 
sels  were  not  previously  ranked  as  American  and  had  to  sail  under  alien  flags. 
But  the  new  law  does  not  permit  foreign-built  ships  to  engage  in  the  coasting 
trade. 

1  If  the  latter  carried  goods  more  cheaply,  they  could  drive  out  foreign  rivals 
without  legal  aid. 


ENCOURAGEMENT  OF  TRANSPORTATION  157 


carrying  these  goods  rest  as  a  burden  on  the  consumers 
of  those  other  countries. 

The  main  argument  against  navigation  laws  is  the  same 
as  that  against  protection.  Like  protection,  it  diverts 
labor  and  capital  from  lines  which  they  would  otherwise 
follow,  into  relatively  unprofitable  lines.  These  laws  are, 
therefore,  as  indefensible,  economically,  as  are  protec¬ 
tive  tariffs.  Where  navigation  laws  would  be  likely  to 
develop  a  national  marine,  able,  eventually,  to  compete 
in  the  world’s  commerce  successfully  without  aid,  there 
is  a  reasonable  probability  that  conditions  are  favorable 
to  this  success  and  that  it  would  be  attained  in  time 
without  government  coddling.  Where,  in  spite  of  navi¬ 
gation  laws  intended  to  develop  a  national  marine,  abil¬ 
ity  to  compete  outside  of  the  protected  limits  is  never 
attained,  the  protective  laws  involve  a  continuous  burden 
on  the  general  public.  Whatever  military  justification 
may  exist  for  such  protection  to  national  navigation, 
economic  justification  is  usually  absent,  and  is  probably 
always  of  doubtful  weight. 


Subsidies  to  Native  Shipping 

Another  method  of  encouraging  a  national  mercan¬ 
tile  marine  is  that  of  paying  so-called  shipping  subsidies. 
Shipping  subsidies  are  simply  bounties  paid  to  the  ship¬ 
ping  industry.  What  was  said  in  Chapter  VII  (of  Part  II) 
regarding  bounties  applies,  therefore,  to  shipping  subsidies. 
Like  bounties  and  like  protective  tariffs,  shipping  sub¬ 
sidies  divert  national  industry  out  of  its  natural  lines 
into  a  line  which,  without  such  encouragement,  it  prob¬ 
ably  would  not  follow,  or  which  it  would  not  follow  to 


158  ECONOMIC  ADVANTAGES  OF  COMMERCE 


the  same  extent.  Unlike  protection,  subsidies  do  not 
exclude  foreign  competition,  but  simply  endeavor,  by 
money  payments,  to  make  it  possible  for  the  national 
marine  to  meet  this  competition.  As  with  other  bounties, 
therefore,  the  burden  falls  upon  taxpayers,  rather  than 
upon  shippers  or  ultimate  consumers.  The  two  last 
classes  may  even  gain  somewhat,  if  a  subsidy  is  sufficient 
to  cause  lower  freight  rates  in  spite  of  the  greater  cost  of 
transportation  in  native  ships.  But  even  these  classes 
will  gain  nothing  if  a  subsidy  is  just  high  enough  to  en¬ 
able  native  ships,  previously  unable  to  compete,  to  charge 
rates  no  higher  (and  no  lower)  than  those  charged  by 
foreign  ships. 

One  of  the  cruder  arguments  for  subsidies,  as  for  pro¬ 
tective  tariffs,  is  to  the  effect  that  when  we  patronize 
foreign  vessels  we  have  to  send  our  money  abroad,  and 
that  we  would  “  save  ”  this  money  if  we  carried  the  freight 
in  our  own  vessels.  As  a  matter  of  fact,  money  is  not 
the  one  thing  for  which  trade,  in  the  last  analysis,  is 
carried  on.  Furthermore,  if  money  flows  out  unduly,  it 
thereupon  begins  to  flow  back  again,  in  accordance  with 
the  principles  which  we  have  so  often  set  forth  in  previous 
chapters.1  As  regards  the  most  economical  directions 
of  industrial  and  commercial  development,  it  should 
be  apparent  that  if  British  or  other  ships  can  carry  goods 
more  cheaply  than  our  own  merchant  marine,  then  our 
labor  may  better  be  devoted  to  the  lines  where  it  yields 
greater  returns,  to  services  which  others  cannot  so  well  per¬ 
form  for  us,  to  our  factories,  farms,  mines,  and  railroads. 
If  American  labor  is  more  profitable  when  devoted,  for 
instance,  to  the  running  of  railroad  trains,  then  it  is  poor 
economic  policy  to  draw  it,  by  subsidies,  into  the  running 
of  ships. 

1  See,  for  example,  Part  I,  Cb.  V,  §§  6,  7,  S. 


ENCOURAGEMENT  OF  TRANSPORTATION  159 


Another  argument  for  subsidies  is  based  on  the  asser¬ 
tion  that  “  trade  follows  the  flag.”  This  assertion,  used 
in  relation  to  subsidies,  suggests  that  a  national  merchant 
marine  acts  as  a  species  of  advertisement,  that,  for  ex¬ 
ample,  the  American  flag  flying  at  the  mast  head  of  a 
merchant  ship  will  stimulate  a  desire  in  South  America 
or  elsewhere,  to  examine,  and,  therefore,  eventually  to 
buy,  American  goods.  Except  for  purposes  of  adver¬ 
tisement,  foreign  ships  serve  as  well  to  carry  American 
goods  to  market  as  do  American  ships,  and  better  in 
proportion  as  they  carry  these  goods  more  cheaply. 

Probably  there  is  some  advertisement  for  a  country’s 
goods  in  the  ubiquitousness  of  its  merchant  ships.  Yet 
we  must  beware  of  exaggerating  the  amount  and  the 
value  of  this  advertisement,  and  of  overlooking  its  cost. 
France  has  made  considerable  effort  to  develop  shipping 
and  has  hoped  thereby  to  develop  foreign  commerce, 
while  the  United  States  has  done  almost  nothing  to  stim¬ 
ulate  foreign  trade  in  American  ships ;  yet  a  practically 
stationary  foreign  commerce  of  the  former  country  has 
been  contemporaneous  with  an  extensive  growth  of  the 
commerce  of  the  latter.1  “The  history  of  the  world’s 
commerce  seems  to  show  conclusively  that  the  nation¬ 
ality  of  ship  owners  is  quite  a  secondary  matter  in  the 
development  of  trade.”  2 

So  far  as  the  presence  of  a  nation’s  ships,  e.g.  American 
ships,  on  the  high  seas  and  in  foreign  harbors,  really  tends 
by  its  advertisement  to  stimulate  American  export 
trade,  it  would  seem  that  the  persons  having  to  pay  for 
this  advertisement  should  be  those  who  expected  to 
reap  special  gain*  from  it.  Why  should  not  merchants 

1  Meeker,  History  of  Shipping  Subsidies  (in  publications  of  the  American 
Economic  Association*  August,  1905),  p.  213.  2  Ibid. 


160  ECONOMIC  ADVANTAGES  OF  COMMERCE 


and  manufacturers  who  are  interested  in  exploiting  the 
trade  of  any  part  of  the  world,  and  who  seriously  think 
that  the  presence  there  of  vessels  flying  the  American 
flag  will  bring  them  a  larger  market,  be  willing  to  sub¬ 
scribe  to  the  stock  of  American  lines,  or  pay  a  little  extra 
to  have  their  goods  carried  in  American  vessels,  or  both  ? 
Is  it  not  possible  that  American  merchants  and  manu¬ 
facturers  will  not  do  this  to  any  great  extent,  because  the 
gain  would  be  so  small  as  not  to  equal  the  cost  ?  Hard- 
headed  business  men  spend  a  great  deal  of  money  in  ad¬ 
vertising.  Some  of  them  are  enthusiastic  over  the  as¬ 
sumed  gains  of  this  particular  kind  of  advertising  if  it 
is  proposed  that  it  shall  be  done  at  public  expense  by 
means  of  subsidies.  But  would  they  consider  the  rather 
problematical  results  of  such  indirect  and  indefinite 
advertising  worth  paying  for  out  of  their  own  business 
,  profits?  By  the  subsidy  method,  many  persons  and 
many  sections  of  the  country  are  taxed  to  secure  results 
which  may  be  of  little  or  no  benefit  to  them  and  which 
are  probably  of  not  very  much  benefit  to  any  one. 

Another  argument  in  favor  of  subsidies  is  one  that 
corresponds  to  the  infant  industry  argument  for  protec¬ 
tion.  It  is  urged,  in  this  view,  that  subsidies  should 
be  given  to  divert  industrial  and  commercial  activity 
more  largely  into  shipping,  in  the  hope  that  the  mer¬ 
chant  marine  will  develop  in  efficiency  until  it  is  able  to 
stand  alone.  An  important  counter-argument  is  the  fact 
that  no  one  is  able  to  foresee  with  any  certainty  whether 
or  not  the  shipping  industry  ever  can  stand  alone  and 
that  legislators  are  less  likely  to  risk  the  public  wealth 
wisely  than  business  men  are  to  risk  their  own.  There 
is  great  danger  that  subsidies,  once  started,  would  con¬ 
tinue  indefinitely  on  the  plea  that  they  continued  to  be 


ENCOURAGEMENT  OF  TRANSPORTATION  161 


necessary.1  And  if,  as  a  consequence  of  a  subsidy  system, 
the  national  mercantile  marine  should  become  larger, 
though  at  the  general  expense,  then  the  political  pressure 
to  maintain  the  subsidy  system  would  very  probably 
become  greater.  It  is  altogether  too  probable  that  if 
the  giving  of  subsidies  is  generally  recognized  as  a  proper 
function  of  government,  men  who  would  otherwise  de¬ 
vote  themselves  to  planning  improvements  and  to  seek¬ 
ing  real  progress  in  efficiency,  will  instead  devote  them¬ 
selves  to  influencing  political  action,  in  order  that  they 
may  get,  or  maintain,  or  increase,  a  subsidy.2  This 
method  of  acquiring  gain  is  not  consistent  with  the  ideal 
of  industrial  and  commercial  morality.  Industry  and 
commerce  should  be  so  organized  that  profits  will  be  made 
only  by  serving  the  public,  and  that  profits  will  be  large 
to  any  person  or  firm  in  proportion  as  that  person  or  firm 
serves  the  public  well.  The  prosperity  of  those  engaged 
in  operating  a  nation’s  merchant  marine  ought  not  to  be 
made  dependent  upon  their  political  influence  rather  than 
upon  their  economic  service. 

Apart  from  purely  economic  considerations,  shipping 
subsidies  are  sometimes  urged  as  a  means  of  increasing  a 
nation’s  naval  strength.  Two  principal  naval  reasons 
are  commonly  given  for  the  maintenance  of  a  merchant 
marine,  even  at  the  expense  of  a  subsidy.  The  first  is 
the  desirability  of  having  a  “naval  reserve”  made  up  of 
large  and  swift  merchant  steamers  suitable  for  conver¬ 
sion  into  cruisers,  colliers,  and  transports,  should  need 
for  such  arise.  As  a  matter  of  fact,  it  is  only  as  colliers 
and  transports  that  such  vessels  are  likely  to  be  useful, 
since  ships  of  war  are  nowadays  highly  specialized,  and 

1  Meeker,  History  of  Shipping  Subsidies,  p.  81. 

2  Ibid.,  p.  216. 


PART  n  —  M 


162  economic  advantages  of  commerce 


merchant  vessels  cannot,  economically,  be  made  over 
into  cruisers.1  The  second  reason  is  the  desirability  of 
having  experienced  seamen  from  whom  to  recruit  colliers, 
transports,  and  additional  fighting  ships  when  war  threat¬ 
ens,  to  replace  those  killed  and  wounded,  to  hold  cap¬ 
tured  vessels,  etc. 

These  objects  may  be  perfectly  justifiable,  even  laud¬ 
able,  in  themselves.  And  it  may  be  cheaper  to  pay 
subsidies  to  certain  lines,  thus  helping  to  keep  them  in 
ships  and  men  capable  of  emergency  use  by  government, 
but  letting  them  be  mainly  supported  by  commerce, 
than  to  support,  continuously,  and  wholly  at  public  ex¬ 
pense,  a  larger  naval  force.  But  if  the  policy  of  sub¬ 
sidizing  ships  appears  necessary  to  us  for  military 
reasons,  we  should  frankly  recognize  that  this  policy 
involves  an  economic  loss,  that  it  is  an  expense  borne 
for  the  same  purpose  as  the  expense  of  maintaining  a  navy. 
We  should  not  deceive  ourselves  into  the  belief  that  the 
subsidizing  of  ocean  navigation  is  an  economically  profit¬ 
able  policy.  We  should  therefore  aim  to  get  the  largest 
military  result  possible  at  the  smallest  possible  cost. 
Large  payments  to  swift  mail  lines  and  possibly  to  cer¬ 
tain  other  ships  constructed  for  speed  and  carrying  ca¬ 
pacity  and  conforming,  in  other  ways,  to  possible  emer¬ 
gency  requirements,  mark  the  limit  beyond  which  we 
should  not  go  in  subsidizing,  even  if  we  should  go  so  far. 
Subsidies  granted  according  to  these  principles  are  pay¬ 
ments  for  certain  definite  services  or  potential  services, 
and  are  not  to  be  classed  with  subsidies  granted  for 
purely  commercial  reasons. 

1  Meeker,  History  of  Shipping  Subsidies,  p.  215. 


ENCOURAGEMENT  OF  TRANSPORTATION  163 


Indirect  Subsidies ,  Favoring  Native  Ships  as  Compared 

with  Foreign  Ships 


A  country  may  try  to  extend  and  develop  its  own 
merchant  marine,  to  the  consequent  decrease  (or  slower 
increase)  of  the  number  of  foreign  ships,  by  indirect  as 
well  as  by  direct  subsidies.  Any  service  which  a  coun¬ 
try,  through  its  government,  performs  for  its  own  ships 
without  pay,  while  charging  foreign  vessels  for  it,  is 
equivalent  to  a  money  subsidy. 

Were  it  not  for  clear  treaty  obligations,  there  would 
probably  be,  in  the  United  States,  as  strong  a  demand 
for  free  use  of  the  Panama  Canal  by  all  of  our  American 
merchant  ships,  as  there  has  actually  been  for  its  free 
use  by  American  vessels  engaged  in  the  coasting  trade.1 
To  let  American  vessels  use  the  Panama  Canal  free  would 
be  equivalent  to  a  money  subsidy,  because  it  would 
amount  to  the  same  thing  as  to  make  a  charge  for  the 
use  of  the  canal  and  then  to  make  a  payment  equalling 
this  charge,  to  American  shipping  interests.  In  either 
case,  the  taxpayers  of  the  nation  would  bear  a  burden, 
or  lose  a  chance  for  lower  taxes,  that  special  interests 
might  be  encouraged.  For  if  letting  American  ships 
use  the  canal  free  would  mean  that  the  canal  could  never 
pay  a  reasonable  return  on  its  cost,  then  taxpayers  must 
meet  the  deficit  by  taxes  paid  to  government  over  a 
series  of  years,  in  order  to  liquidate,  or  at  least  pay  in¬ 
terest  upon,  the  indebtedness  caused  by  building.  If, 
on  the  other  hand,  though  all  American  ships  used  the 
canal  free  of  tolls,  the  amounts  collected  from  foreign 


1  For  a  discussion  of  the  economic  advisability  of  giving  American  coasting 
lines  this  special  privilege,  see  §  4  of  this  chapter  (VIII  of  Part  II). 


1 64  ECONOMIC  ADVANTAGES  OF  COMMERCE 


ships  would  suffice  to  pay  interest  on  the  debt  contracted, 
still  this  interest  might  be  had  and  more  besides,  were 
the  American  lines  also  made  to  contribute.1  In  other 
words,  to  allow  American  ships  free  use  of  the  canal  must, 
in  any  case,  mean  either  a  loss  or  a  smaller  net  revenue 
yielded  to  the  government  than  might  otherwise  be 
yielded.  If  the  canal  is  to  yield  the  nation  a  revenue 
because  of  its  use  by  foreign  ships,  that  revenue  should 
be  used  to  lighten  the  burden  of  taxation  on  the  whole 
people ;  it  should  not  be  used  to  encourage  a  single  in¬ 
dustry  by  giving  it  something  for  nothing.  Thus  to  en¬ 
courage  American  shipping  would  be  to  give  it  an  artifi¬ 
cial  advantage  over  other  American  industries,  and  would 
be,  in  so  far,  to  interfere  with  the  tendency  of  labor  and 
capital  to  engage  in  the  industries  really  most  profitable 
for  the  nation.  There  is  no  economic  gain 2  in  having 
our  commerce  carried  in  American  ships  if  foreign  ships 
are  able  to  carry  it  more  cheaply.  Nor  would  the  pros¬ 
perity  of  the  nation  as  a  whole,  including  those  who  bear 
the  burden  of  taxation,  be  so  much  furthered  by  having 
our  commerce  carried  in  American  ships  which  could 
pay  little  or  nothing  for  the  use  of  the  canal,  as  by 
having  it  carried  in  foreign  vessels  which  could  pay  a 
reasonable  amount  for  its  use  without  charging  corre¬ 
spondingly  higher  transportation  rates.  Assuming  these 
to  be  the  relative  abilities  of  native  and  foreign  vessels, 

1  It  is  not  intended  to  assert  that  either  American  or  foreign  ships  should  be 
charged  exorbitant  rates.  Such  rates  on  ships  carrying  American  commerce, 
of  whatever  nationality  the  ships  might  be,  would  tend  to  discourage  this  com¬ 
merce,  even  when  it  could  pay  the  proper  costs  of  its  own  movement  and  would 
therefore  be  profitable.  As  to  the  effect  on  American  welfare  of  exorbitant 
rates  charged  ships  not  carrying  American  commerce,  see  footnote  at  end  of  this 
section. 

2  Unless  we  assume  a  gain  from  the  advertisement  thus  secured.  See  §  2  of 
this  chapter  (VIII  of  Part  II). 


ENCOURAGEMENT  OF  TRANSPORTATION  165 


the  foreign  vessels  would  be  a  more  economical  means 
for  us  of  carrying  our  commerce  than  our  own;  for 
them  to  carry  it  would  mean  either  lower  rates  and, 
therefore,  lower  prices  to  consumers  and  higher  prices 
to  producers,  or  larger  returns  to  the  government,  favor¬ 
able  to  taxpayers,  or  both  such  lower  rates  and  higher 
prices ;  for  them  to  carry  our  commerce  would  mean  gain 
to  our  people  as  producers  and  consumers,  or  as  tax¬ 
payers,  or  as  both.  It  would  be  desirable,  therefore, 
for  our  capital  and  labor  to  seek  other  kinds  of  activity ; 
but  this  is  just  what  discrimination  in  the  rates  charged 
for  use  of  the  canal  would  prevent.1 

§  4 

The  Free  Use  for  Navigation  of  Government-built  Canals 

Since  to  give  free  use  of  the  Panama  Canal  to  all  Amer¬ 
ican  ships  and  to  no  others,  seemed  clearly  to  involve 
a  violation  of  treaty  obligations,  Congress  was  content, 
in  the  Panama  Canal  Act  of  1912,  to  confer  this  privi¬ 
lege  only  upon  American  ships  engaged  in  the  coasting 
trade.  Even  this  lesser  tolls  exemption  appeared  to 
many  to  be  a  violation  of  treaty  rights;  and  the  law 
has  recently, 2  at  the  request  of  President  Wilson,  been 
changed  in  this  regard  so  as  to  require  the  same  charges 
from  American  coasting  vessels  as  from  all  other  mer¬ 
chant  ships.  We  shall  discuss,  here,  the  possible  eco- 

1  Were  we  to  plan, "intelligently,  so  to  discriminate  in  rates  charged  for  use  of 
the  Panama  Canal,  as  to  pay  for  it,  as  largely  as  possible,  at  the  expense  of  for¬ 
eigners,  we  would  base  the  discrimination  on  the  sources  and  destinations  of 
goods  carried,  rather  than  on  the  nationality  of  the  ships  which  carried  them. 
Goods  going  to  and  from  the  United  States  would  be  allowed,  perhaps,  to  pass 
through  the  canal  at  fairly  low  rates,  lest  American  consumers  or  producers  be 
unduly  taxed ;  while  goods  going  from  one  foreign  country  to  another  would  be 
charged  the  highest  rates  possible  to  collect. 

•June,  1914. 


166  ECONOMIC  ADVANTAGES  OF  COMMERCE 


nomic  effects  of  tolls  exemption  for  American  coasting 
ships.  As  we  have  already  seen,1  the  Federal  govern¬ 
ment  assures  American  vessels  a  monopoly  of  the  coast¬ 
ing  trade,  including  the  trade  from  any  port  of  the  United 
States  to  any  other  port,  e.g.  from  Baltimore  to  San 
Francisco.  Free  use  of  the  Panama  Canal  by  American 
vessels  engaged  in  the  coasting  trade  could  not,  there¬ 
fore,  increase  our  mercantile  marine  at  the  expense  of 
foreign  rivals  in  the  trade.  The  primary  effect  of  free 
tolls  to  this  special  class  of  ships  would  be  to  reduce  the 
expense  of  coast  to  coast  trade,  and  therefore,  supposedly, 
to  reduce  rates.  Possibly  foreign  vessels  could  carry  at 
the  lower  rates,  even  without  free  tolls.  If  the  coasting 
trade  were  open  to  foreign  ships,  the  effect  of  discrim¬ 
ination  in  favor  of  American  vessels  engaging  in  this 
trade  might  simply  be  that  the  American  ships  would  be 
able  to  get  part  of  the  trade  away  from  their  foreign 
competitors,  at  substantially  the  same  rates.  As  it  is, 
such  free  tolls  would  tend  to  make  rates  lower  than  they 
would  else  be,  though  much  of  the  saving  might  be  di¬ 
verted  to  the  owners  of  monopolistic  navigation  com¬ 
panies.  Hence  traffic  would  be  encouraged  to  go  through 
the  canal,  which  otherwise  would  not. 

The  construction  of  a  canal  across  the  Isthmus  of 
Panama,  to  be  used  without  charge  by  American  coasting 
vessels,  would  therefore  mean  that  traffic  from  the  East 
to  the  West,  and  vice  versa ,  which  is  not  worth  the 
whole  cost  of  carrying,  might  nevertheless  be  carried 
at  the  expense  of  the  tax-paying  public.  If  it  is  worth 
$5000  to  get  certain  goods  from  New  York  to  San  Fran¬ 
cisco,  and  the  cost  of  carriage,  including  proper  payment 
for  all  necessary  facilities,  is  $6000,  and  if  this  cost  is 

1  §  1  of  this  chapter  (VIII  of  Part  II). 


ENCOURAGEMENT  OF  TRANSPORTATION  167 


covered  by  the  charge  made,  the  goods  will  not  be  sent. 
It  will  be  more  economical  to  have  a  greater  degree  of 
local  self-sufficiency  and  less  geographical  division  of 
labor.  But  if  the  taxpayers  should  contribute  more 
than  $1000  in  the  form  of  maintenance  and  running 
cost  of  the  canal,  and  interest  on  its  cost  of  construction, 
then  the  goods  would  be  shipped,  for  the  charge  to  the 
shippers  could  be  made  less  than  $5000.  The  total  cost 
would  be  $6000  and  the  total  gain  would  be  $5000. 
There  would  be  a  real  net  loss.  But  this  loss  would  be 
borne  by  the  taxpayers,  and  therefore  the  traffic  would 
be  carried. 

Again,  the  encouragement  of  the  coasting  trade  by 
the  building  of  an  Isthmian  ship  canal  to  be  used  by 
coasting  vessels,  free  of  charge,  might  mean  that  goods 
would  be  carried  by  water  or  partly  by  water,  at  the  tax¬ 
payers’  expense,  which  might  be  more  economically 
carried  by  rail.  Suppose  that  a  quantity  of  goods  can 
be  shipped  from  New  York  to  Salt  Lake  City  by  rail  for 
$4000,  including  a  proper  allowance  for  wages  of  em¬ 
ployees  and  something  towards  profits.  Suppose  that, 
at  the  same  time,  the  cost  by  water  and  rail,  including 
risk,  damage,  longer  time  in  transit,  maintenance  cost 
of  the  canal  and  interest  on  canal  facilities  provided, 
is  $5000.  $1000  may  be  saved  if  the  goods  go  by  rail, 

and  to  make  them  go  by  the  other  route,  if  we  include 
interest  on  the  cost  of  partly  constructing  this  route  for 
them,  maintenance  expenses,  etc.,  would  be  to  waste 
$1000.  The  community  or  the  nation  would  be  so  much 
poorer,  yet  if  the  government  were  to  provide  the  $1000 
or  more  in  the  form  of  canal  facilities  paid  for,  eventually, 
by  the  taxpayers,  shippers  would  gain  by  using  the  water¬ 
way  route. 


1 68  ECONOMIC  ADVANTAGES  OF  COMMERCE 


It  is  not  asserted,  of  course,  that  all  goods  ought  to 
pay  in  the  same  proportion  to  use  the  canal,  if  discrimi¬ 
nations  should  prove  to  be  practicable.  If  the  plant 
is  incompletely  utilized,  it  may  not  be  improper  to  let 
some  goods  go  through  for  comparatively  low  rates, 
provided  they  would  not  otherwise  go  at  all.  But  no 
goods  ought  to  be  allowed  to  go  through  which  cannot 
pay  at  least  a  fair  share  towards  running  expenses,  wear 
and  tear  from  use,  and  (probably)  a  little  towards  inter¬ 
est.  And  the  canal  should  not  have  been  built  (mili¬ 
tary  considerations  aside  x),  unless  it  was  expected  that 
the  traffic  through  it,  as  a  whole,  would  be  enough  cheaper 
to  pay  interest  on  it.  To  build  it,  if  it  could  not  be  made 
to  pay,  was  economic  waste,  was,  as  above  pointed  out, 
to  encourage  transportation  not  really  worth  its  total 
cost  to  the  people.  Now  that  the  canal  is  completed,  it 
would  be  unfair  to  the  American  people  as  a  whole  that 
the  traffic  which  goes  through  it  should  not,  if  possible, 
pay  for  it,  that  those  who  realize  the  chief  benefit  should 
not  contribute  in  proportion  to  the  benefit  realized. 

Here,  as  in  the  case  of  protection,  we  meet  the  possibil¬ 
ity  that  government  interference  with  the  direction  of 
industry  may  affect  differently  the  people  of  different 
sections,  benefiting  some  at  the  expense  of  others.  It  is 
obviously  only  that  part  of  our  population  living  on  or 
reasonably  near  the  coast,  which  has  much  to  gain  from 
subsidizing,  directly  or  indirectly,  coast  to  coast  water 
transportation.  Those  living  in  the  far  interior  will,  in 
any  event,  have  to  rely  mainly  on  other  means  of  trans¬ 
portation.  Yet  by  the  scheme  of  indirect  subsidizing 
under  discussion,  but  which  has,  fortunately,  been  aban- 

1  As  a  matter  of  fact,  it  is  hardly  to  be  doubted  that  economic  considerations 
had  great  weight  in  inducing  its  construction. 


ENCOURAGEMENT  OF  TRANSPORTATION  169 


doned,  those  in  the  interior  would  be  made  to  contribute 
to  the  cost  of  facilities  of  transportation  which  others 
use  and  which  they  cannot  use  in  the  same  degree.1 

The  principles  above  elaborated  apply  equally  when 
government  builds  canals  in  the  interior,  if  traffic  is  al¬ 
lowed  to  use  these  canals  free  of  charge.  New  York 
State  is  now  enlarging  the  once  busy  and  profitable  Erie 
Canal  at  an  estimated  cost  of  not  less  than  $100,000,000, 
in  order  that  it  may  carry  barges  of  1000  tons  capacity 
from  the  Atlantic  Ocean  to  the  Great  Lakes  and  vice 
versa.  The  plan  is  to  charge  nothing  for  the  use  of  the 
canal.  This  will  mean  a  burden  on  the  taxpayers  of 
the  state,  an  uncompensated  loss  to  the  taxpayers  in 
those  parts  of  the  state  which  cannot  economically  use 
the  canal  either  to  market  their  produce  or  to  obtain 
goods  for  consumption.  It  amounts  to  a  gift  by  the  tax¬ 
payers  of  the  state  of  New  York  to  those  producers  and 
consumers  in  other  states,  who  can  sell  their  products  for 
more  or  buy  desired  goods  for  less,  because  of  the  free 
use  of  the  Erie  Canal.  It  involves  encouragement  to 
transportation  via  the  canal  of  goods  which  might  better 
go  by  railway  or  by  the  St.  Lawrence  river.  If  the  traffic 
which  is  expected  to  use  the  canal  would  be  able  to  pay 
the  cost  of  operation  and  maintenance,  and  interest  on 
the  $100,000,000  or  more  sunk  and  to  be  sunk,  then  it 
should  be  charged  this  cost  and  interest,  to  the  end  that 
those  who  reap  the  benefit  of  the  canal  in  lower  cost  of 
carriage,  and  in  prices  of  goods  higher  to  producers  and 
lower  to  consumers,  shall  pay  for  the  advantage  so  se- 

1  An  excuse  for  such  discrimination  against  dwellers  in  the  interior  might 
perhaps  be  found  in  the  fact  that  those  living  on  the  coast  chiefly  bear  the  burden 
resulting  from  the  limitation  of  the  coasting  trade  to  American  vessels.  Two 
policies,  each  tending  towards  economic  waste,  would  partially  offset  each  other 
as  regards  inequality  of  effect. 


i7o  ECONOMIC  ADVANTAGES  OF  COMMERCE 


cured ;  and  that  those  who  reap  the  most  gain  shall  pay 
the  most ;  and  to  the  end  that  the  burden  shall  not  fall 
upon  the  general  public  without  any  regard  to  propor¬ 
tionate  use  and  to  benefits  received.1  If,  on  the  other 
hand,  it  is  not  believed  that  those  using  the  canal  can 
meet  such  charges  and  still  find  it  profitable  to  carry 
goods  over  it,  then  we  must  conclude  that  the  canal 
ought  not  to  be  (or,  in  part,  to  have  been)  enlarged, 
since  the  total  expenses,  including  cost  of  this  enlarge¬ 
ment,  of  carrying  goods  over  it,  will  probably  be  greater 
than  the  benefits  to  be  received  from  transporting  the 
goods,  or  will  be  greater  than  if  the  goods  were  carried 
over  another  route,  e.g.  a  railroad. 

Before  the  days  of  railroads,  much  confidence  was  felt 
in  the  possibilities  of  canals.  A  number  of  our  states 
expended  a  great  deal  of  money  in  canal  building.  To¬ 
day  it  is  generally  recognized  that,  since  the  capital  cost 
of  canals  is  a  tremendous  initial  expense,  railroads  are 
generally  cheaper.  Only  in  a  comparatively  few  cases 
can  canal  building  be  expected  to  pay.  These  are,  first, 
cases  where  the  canals  connect  navigable  waters  located 
near  to  each  other,  and  between  which,  if  they  are  con¬ 
nected  by  a  canal,  there  will  be  large  traffic ;  second,  cases 
where  comparatively  short  canals,  like  the  Suez  Canal, 
save  a  very  great  sailing  distance  and  so  are  extensively 
used ;  third,  cases  more  doubtful,  where  short  canals  con¬ 
nect  with  the  ocean,  great  cities  which  have  grown  up  not 

1  It  is  no  sufficient  answer  to  this  contention  to  cite  the  usual  practice  regard¬ 
ing  our  numerous  streets  and  roads.  To  charge  tolls,  individually,  on  each 
person  as  he  used  any  given  street,  would  obviously  be  an  intolerable  nuisance. 
These  facilities  we  must  have,  anyway,  and  substantial  justice  may  be  secured, 
if  care  is  taken  to  avoid  extravagance,  by  levying  on  local  property  owners  accord¬ 
ing  to  some  fair  system.  Since  land  values  depend  largely  on  streets,  etc.,  it 
may  be  possible,  by  basing  assessments  or  taxes  on  land  values,  to  make  costs 
to  different  persons  vary,  on  the  whole,  in  proportion  to  benefits. 


ENCOURAGEMENT  OF  TRANSPORTATION  171 


far  from  it.1  “  Practically  all  the  canals  now  in  most  suc¬ 
cessful  use  are  ship  canals,  forming  comparatively  short 
links  between  important  natural  waterways,  and  opening 
up  extended  routes  of  transportation  by  water  for  large 
vessels.  Such  short-link  ship  canals  are  to  be  clearly 
distinguished  from  long  inland  canals,  and  the  success 
of  the  one  offers  no  safe  criterion  as  to  the  probable 
success  of  the  other.  ”  2  Moulton’s  study  of  the  much 
vaunted  waterway  system  of  Germany  seems  to  provide 
conclusive  evidence  that  canals  are  as  cheap  as  railways 
for  shippers,  only  if  the  taxpayers,  in  effect,  help  pay  the 
freight,  and  that,  in  general,  canals  and  canalized  rivers 
involve  tremendous  loss  to  the  nation  which  undertakes 
their  construction,  and  are  therefore  a  source  of  indus¬ 
trial  and  commercial  weakness  rather  than  of  strength.3 

If  there  were  adequate  reason  to  believe  that  canals, 
generally,  were  cheaper  and  more  satisfactory  means  of 
transportation  than  railroads,  it  would  not  be  necessary 
to  have  public  agitation  and  political  pressure  to  get 
canals  built.  Private  companies  would  undertake  to 
build  them  for  profit,  just  as  they  build  railroads  for 
profit,  and  just  as  canals  were  built,  in  England  particu¬ 
larly,  before  the  days  of  railroads.4  As  a  matter  of  fact, 
investors  are  not  clamoring  for  a  chance  to  buy  the  securi¬ 
ties  of  such  companies,  nor  are  promoters  eagerly  looking 
for  opportunities  to  project  new  lines.  When  the  build- 

1  Preliminary  Report  of  United  States  National  Waterways  Commission, 
1911,  pp.  13,  14.  Reprinted  in  Final  Report,  1912,  pp.  75,  76.  See,  however, 
as  to  an  example  of  the  third  class  of  cases,  viz.  the  Manchester  Ship  Canal, 
Moulton,  Waterways  versus  Railways,  Boston  and  New  York  (Houghton  Mif¬ 
flin  Co.),  1912,  Ch.  VII. 

2  Report  of  Commissioner  of  Corporations  on  Transportation  by  Water  in 
the  United  States,  Part  I,  p.  45. 

*  Moulton,  Waterways  versus  Railways,  Chs.  IX,  X. 

4  Ibid.,  p.  99. 


172  ECONOMIC  ADVANTAGES  OF  COMMERCE 

ing  of  canals  is  mentioned  favorably,  the  assumption  is 
always  made  that  taxpayers  shall  bear  the  burden,  or 
at  least  the  risk,  of  building  them. 

§  5 

The  Improvement  of  Harbors 

Water  transportation  which  is  not  worth  its  cost,  may 
likewise  be  stimulated  by  a  wrong  system  of  harbor  im¬ 
provement.  In  the  United  States,  the  construction  and 
care  of  lighthouses,  the  building  of  breakwaters,  the 
dredging  of  harbors,  and  the  dredging  of  channels  between 
the  sea  and  harbors,  are  done  largely  by  the  Federal  gov¬ 
ernment.1  It  cannot  be  said  that  nothing  is  paid  to¬ 
wards  the  expenses  involved,  by  the  traffic  aided,  since  the 
tonnage  dues  collected  by  the  government  amount  to 
$800,000  or  $900,000  a  year.2  But  considering  the  fact 
that  the  Federal  government  appropriates  about  $5,000- 
000  a  year  for  lighthouse  maintenance  alone,3  and,  on 
the  average,  appropriates  millions  of  dollars  each  year 
for  dredging,  breakwater  construction,  etc.,  the  traffic 
entering  and  leaving  the  ports  of  the  United  States  can¬ 
not  be  said  to  bear  the  costs  which  it  occasions.  Rather 
is  this  traffic,  in  a  considerable  degree,  subsidized  at  the 
expense  of  taxpayers.  As  with  canals,  so  with  light¬ 
houses  and  harbors,  we  must  conclude  that  those  who 
benefit  by  them  should  be  the  ones  required  to  pay  for 
them,  and  that  to  place  the  burden  of  their  construction 

1  Report  of  Commissioner  of  Corporations  on  Transportation  by  W ater  in  the 
United  States,  Part  III,  1909,  pp.  39,  40. 

2  Johnson,  Ocean  and  Inland  Water  Transportation,  New  York  (Appleton), 
1911,  p.  252.  Given  in  Report  of  Commissioner  of  Corporations  on  Transporta¬ 
tion  by  Water  in  the  United  States,  Part  I,  p.  404,  as  $1,076,571.69  in  1908. 
The  coasting  trade  is  free  even  from  this. 

3  Ibid.,  p.  262. 


ENCOURAGEMENT  OF  TRANSPORTATION  173 


and  support  on  the  general  public,  with  no  reference  to 
benefit  received,  is  undesirable  and  unfair.1  We  must 
further  conclude  that  constructions  and  improvements 
made  in  harbors,  for  which  the  traffic  using  the  harbors 
cannot  afford  to  pay,  involve  national  economic  loss  and 
ought  not  to  be  undertaken. 

In  many  cases  the  money  spent  in  harbor  improve¬ 
ments  by  the  Federal  government  is  wholly  or  partly 
wasted,  for  appropriations  are  frequently  made  for  which 
there  is  no  economic  justification  and  for  which  there 
would  be  no  economic  justification  even  if  the  largest 
sums  possible  were  to  be  realized  by  charging  the  users. 
Such  wasteful  appropriations  are  doubtless  in  part  due 
to  lack  of  business  sense  among  legislators.  They  are 
perhaps  more  largely  due  to  the  pressure  of  local  interests. 
The  very  fact  that  these  appropriations  are  so  largely 
made  by  the  central  government,  and  that  there  is,  or 
seems  to  be,  a  chance  for  interested  localities  to  get  some¬ 
thing  for  nothing,  results  in  expenditures  which  would 
not  be  made  if  the  localities  particularly  concerned  had 
always  to  provide  the  means,  or  if  private  capital  had  to 
be  induced  to  do  so.2 

1  It  is  not  a  sufficient  answer  to  the  above  argument,  to  assert  that  our  tariff 
system  taxes  trade  and  that  therefore  this  trade  pays  for  itself  by  paying  for 
the  facilities  used.  For  the  burden,  nevertheless,  does  not  fall  where  it  properly 
belongs.  It  does  not  fall  anything  like  evenly  on  all  traffic  which  uses  the  facil¬ 
ities  provided.  On  some  goods  the  tariff  has  been,  until  recently,  prohibitive, 
artificially  interfering  with  normal  and  profitable  trade.  On  other  commerce 
and  on  passenger  traffic,  the  tariff  duties  are  little  or  nothing.  Such  commerce  and 
traffic  may,  in  effect,  be  receiving  a  subsidy,  while  the  remainder  of  commerce 
is  burdened.  The  principle  of  charging  the  cost  of  facilities  provided,  to  those 
who  use  them  and  upon  different  interests  in  some  proper  proportion  to  the 
benefit  received,  is  not  conformed  to.  We  fall  far  short  of  the  economic  ideal 
when  we  set  up  contradictory  policies  of  discouragement  and  encouragement. 
These  contradictory  policies  do  not  exactly  neutralize  each  other,  but  in  one  case 
there  is  a  net  loss  in  one  direction,  and  elsewhere  there  is  a  net  loss  in  another 
direction. 

2  Cf.  Preliminary  Report  of  National  Waterways  Commission,  p.  20  (Final 
Report,  p.  82). 


174  ECONOMIC  ADVANTAGES  OF  COMMERCE 


A  different  system,  and  one  which  is  economically 
more  defensible,  is  that  common  in  Great  Britain.  There 
the  central  government,  except  as  naval  considerations 
may  be  involved,  does  nothing  whatever  by  way  of  har¬ 
bor  improvement,  but  leaves  this  matter  to  the  localities 
immediately  concerned.  The  British  system  of  harbor 
improvement  and  maintenance  requires  the  creation  for 
each  harbor  of  a  so-called  “public  trust”  or  public  harbor 
trust.1  A  public  harbor  trust  is  a  semi-public  body  or  a 
corporation,  authorized  by  parliament,  to  which  body  is 
granted  power  to  own,  improve,  and  manage  a  particu¬ 
lar  harbor.  It  has  been  compared 2  to  the  board  of 
trustees  of  an  American  university  or  charitable  institu¬ 
tion.  The  members  receive  no  salaries,  but  regard  their 
position  as  an  honorary  one.  The  composition  of  a 
harbor  trust  is  determined  by  statute.  Representatives 
are  usually  selected  by  the  British  government,  the 
government  of  the  city  concerned,  boards  of  trade  and 
chambers  of  commerce,  ship  owners’  associations,  and 
other  interested  parties.  Money  is  borrowed  for  neces¬ 
sary  improvements,  usually  at  low  rates,  for  the  harbor 
trust  is  authorized  to  collect  port  and  dock  charges  from 
vessels  utilizing  the  facilities  given,  and  this  power  makes 
the  security  good,  at  least  in  the  case  of  a  port  sure  to  have 
large  traffic.  Sometimes  money  is  borrowed  from  the 
municipality  itself.  In  any  case,  money  needed  in  excess 
of  what  has  been  collected  in  previous  years  from  traffic, 
is  borrowed,  and  must  be  paid  back  out  of  future  collec¬ 
tions.  There  are  no  stockholders,  and,  therefore,  there 
is  no  attempt  to  make  a  profit  above  a  fair  interest  and 

1  Described  in  Smith,  The  Organization  of  Ocean  Commerce,  Philadelphia 
(Publications  of  the  University  of  Pennsylvania),  1905,  pp.  129,  130. 

2  Ibid. 


ENCOURAGEMENT  OF  TRANSPORTATION  175 


sinking  fund.  Indeed,  a  private  corporation  authorized 
to  collect  tolls  from  all  the  shipping  of  a  port,  for  the  sake 
of  dividends  to  stockholders,  would,  unless  strictly  regu¬ 
lated,  be  an  intolerable  monopoly. 

But  the  British  system  of  harbor  control  does  make 
the  traffic  pay  for  the  facilities  required,  and  is  in  so  far 
consistent  with  the  economic  principles  so  wisely  applied 
to  British  trade  and  commerce  generally.  There  is  no 
attempt  to  encourage  trade  which  is  not  nationally 
profitable,  by  partly  supporting  it,  i.e.  by  providing  free 
harbor  facilities  at  public  expense  and,  therefore,  at  the 
expense  of  other  lines  of  economic  activity,  any  more 
than  there  is  the  attempt  to  interfere  with  nationally 
profitable  trade  by  high  tariff  duties.  The  public  trust 
unites  responsibility  with  direct  action.  It  furthers 
efficiency,  economy,  and  lowness  of  rates,  but  it  does  not 
subsidize. 

The  function  of  maintaining  lighthouses,  however, 
almost  of  necessity  devolves  upon  a  central  government. 
No  city  or  private  corporation  is  in  a  position  to  perform 
this  function  and  make  the  traffic  benefited  pay  for  the 
service  provided,  since  much  of  the  benefit  will  be  received 
by  vessels  which  have  no  occasion  to  visit  the  particular 
city  or  to  come  within  reach  of  the  particular  corporation. 
The  British  government,  therefore,  maintains  the  light¬ 
houses,  but  collects  “ light  dues”  in  return,  amounting 
to  about  $2,500,000  yearly,  from  vessels  entering  English 
harbors.  These  dues  pay  the  entire  yearly  cost  of  main¬ 
taining  the  lighthouses  and  about  $250,000  a  year  be¬ 
sides.1  Here,  also,  is  no  policy  of  subsidizing,  no  attempt 

1  Johnson,  Ocean  and  Inland  Water  Transportation,  p.  262.  If  the  slight 
charge  above  yearly  cost  is  criticised,  it  should  be  remembered  that  a  reason¬ 
able  return  on  investment  is  not  an  improper  aim. 


176  ECONOMIC  ADVANTAGES  OF  COMMERCE 


to  foster  one  industry  at  the  taxpayers’  expense,  or  to 
encourage  an  undue  and  uneconomical  geographical 
division  of  labor. 

§  6 

The  Improvement  of  Rivers 

The  responsibility  for  the  improvement  of  rivers,  like 
that  for  the  improvement  of  harbors,  has  rested,  in  the 
United  States,  chiefly  with  the  Federal  government. 
The  work  done  has  included  the  removal  of  obstructions 
to  navigation,  the  deepening  of  channels  by  dredging,  the 
construction  of  revetments,  and  the  development  of  slack 
water  navigation  by  the  building  of  locks  and  dams  to 
maintain  a  navigable  depth.  Improvements  of  this  sort 
have  been  carried  out,  to  some  extent,  on  most  of  the 
navigable  rivers  of  the  country.  But  the  appropria¬ 
tions  of  Congress  for  these  purposes  have  not  always 
been  wisely  made,  nor  has  the  distribution  of  improve¬ 
ments  throughout  the  country  been  influenced  solely  by 
commercial  or  economic  considerations. 

Let  us  notice  one  or  two  typical  instances  of  Federal 
activity  in  river  improving.  To  improve  the  Mississippi 
river,  the  government  has  spent,  in  all,  more  than 
Sgojooo^oo.1  Of  this  amount,  $15,000,000  has  been 
spent  on  the  200  mile  stretch  between  the  mouths  of  the 
Missouri  and  Ohio  rivers.2  But  the  traffic  on  this 
stretch  of  the  river,  including  that  of  St.  Louis  (which 
is  located  between  these  points  near  the  Missouri),  has 
steadily  decreased.  In  1880,  upwards  of  a  million  tons 

1  The  Report  of  the  Commissioner  of  Corporations  on  Transportation  by  Water 
in  the  United  States,  1909,  Part  I,  p.  47,  gives  $97,685,920. 

7 1  he  facts  and  figures  in  this  and  the  next  paragraph  are  taken  chiefly  from 
an  aiticle  by  Herbert  Brace  Fuller,  in  the  Century  Magazine,  January,  1913, 
pp.  386-395,  entitled  “American  Waterways  and  the  Pork  Barrel.” 


ENCOURAGEMENT  OF  TRANSPORTATION  177 


of  freight  were  shipped  from  St.  Louis.  In  1900,  the 
amount  aggregated  only  245,000  tons,  and  in  1911,  only 
191,965  tons.  Is  it  safe  to  assume  that  there  has  been  so 
much  saving  in  the  expense  of  carrying  this  traffic,  as 
compared  with  what  it  would  have  cost  to  carry  it  by 
rail,  or  to  carry  it  on  the  unimproved  river,  as  to  compen¬ 
sate  for  the  money  sunk  ?  Would  those  who  have  used 
this  section  of  the  river  have  been  willing  to  invest, 
jointly,  the  $15,000,000,  in  order  to  have  the  better 
navigation  conditions  which  that  investment  has  made 
possible  ? 

If  there  remains  any  doubt  in  this  case  that  money 
has  been  unwisely  spent,  there  can  be  no  doubt  in  other 
cases  that  public  funds  have  been  wasted  for  the  sake  of 
returns  to  private  interests  and  to  limited  territories, 
almost  incomparably  less  than  the  general  loss.  The  Big 
Sandy  river  is  a  tributary  of  the  Ohio  river.  The  Big 
Sandy  and  its  two  branches  or  tributaries,  the  Tug  and 
Levisa  rivers,  lie  in  Kentucky  and  West  Virginia.  On 
their  improvement,  the  Federal  government  has  spent, 
in  all,  about  $1,700,000.  Excluding  timber,  which  can 
be  and  commonly  is  floated  down-stream,  the  average 
yearly  traffic  on  these  rivers  is  about  2000  tons.  Reck¬ 
oning  interest  on  this  $1,700,000  as  only  $40,000,  or  less 
than  2 1  per  cent  a  year,  the  annual  cost  to  the  United 
States  of  providing  facilities  for  this  traffic  is  $20  per 
ton  a  year.  Adding  $20,000  a  year  for  maintenance, 
we  have  a  cost  of  $30  a  ton. 

Average  railroad  charges  in  the  United  States  are  con¬ 
siderably  less  than  one  cent  per  ton  mile.1  For  low 
grade  freight  (the  only  kind  which  makes  much  use  of 

1  Statistics  of  Railways  in  the  United  States,  Interstate  Commerce  Com¬ 
mission,  1910,  p.  59. 


PART  n  —  N 


178  ECONOMIC  ADVANTAGES  OF  COMMERCE 


inland  waterways)  going  long  distances,  railroad  charges 
average  very  much  less  than  this,  probably  markedly 
less  than  a  half  cent.  The  facilities  provided  by  the 
government  on  the  above  mentioned  three  rivers  would, 
therefore,  have  to  reduce  the  transportation  cost  upon 
them  to  zero,  in  order  that  the  construction  or  invest¬ 
ment  by  the  government  should  be  proved  worth  while, 
unless  the  traffic  benefited  moved  an  average  distance 
of  over  6000  miles.  For  even  at  zero  cost  of  carriage, 
each  ton  carried  one  mile  would  secure  a  saving  of  but 
one-half  a  cent.  And  unless  it  were  carried  6000  miles, 
the  total  saving  would  not  amount  to  the  $30  interest 
and  maintenance  cost. 

What  is  the  reason  for  the  numerous  appropriations  of 
this  sort  made  by  our  government  ?  A  partial  explana¬ 
tion  may  be  found  in  the  current  American  practice  of 
donating  to  commerce  the  improvements  made,  and 
letting  the  general  public  bear  the  burden  in  indirect 
and,  therefore,  hardly  realized  taxation.  Commercial 
interests  are  the  more  ready  to  plead  for  comparatively 
useless  dredgings,  revetments,  and  canalizations,  because, 
however  small  the  benefits  are,  they  reap  these  benefits, 
and  because,  however  heavy  the  cost  is,  others  mainly 
bear  it.  Any  reform  which  goes  to  the  root  of  the  evil 
must  espouse  the  principle  of  making  those  contribute 
most  to  the  fixed  charges  and  maintenance  costs  of  navi¬ 
gation  improvements,  who  chiefly  use  those  improve¬ 
ments  and  to  whom  their  benefits  chiefly  go. 

A  further  partial  explanation  is  suggested  by  noting 
the  distribution,  throughout  the  country,  of  money 
appropriated  for  waterways.  In  the  general  River  and 
Harbor  Act  of  1910,  appropriations  were  received  by  296 
congressional  districts  in  the  United  States,  out  of  a 


ENCOURAGEMENT  OF  TRANSPORTATION  179 


total  of  39 1,1  in  other  words,  by  over  three-fourths  of 
such  districts.  Apparently  the  appropriations  were 
given  to  nearly  every  district  in  which  there  was  a  stream 
or  harbor  offering  any  excuse  for  expenditure.  This 
River  and  Harbor  Act  illustrates  what  has  been  called 
the  “pork  barrel”  system  of  waterway  development. 

The  difficulty  is  one  which  seems  to  apply  generally  to 
the  activities  of  a  democratic  government.  A  despotic 
or  aristocratic  government  is  based  on  the  privilege  of 
special  persons  or  classes.  It  governs  largely  in  the  in¬ 
terest  of  legally  privileged  classes.  It  insures  to  those 
classes,  political  and  economic  privileges  maintained  at 
the  expense  of  others.  Such  a  government  was  that  of 
France  before  the  Revolution.  Such  is  that  of  Russia 
to-day.  In  the  case  of  a  popular  government  and  an  in¬ 
telligent  people,  privilege  is  probably  less  excessive,  and 
its  forms  less  obnoxious.  But  there  may  still  be,  espe¬ 
cially  if  the  government  carries  on  industrial  functions 
or  interferes  at  all  with  the  natural  laws  of  trade,  the 
privilege  which  comes  from  bargaining.  One  class 
wants  a  special  kind  of  tariff  law,  adverse  to  the  public 
interest.  Another  class  desires  legislation  subversive 
of  currency  stability,  also  contrary  to  the  general  wel¬ 
fare.  The  representatives  of  each,  in  Congress,  may 
support  the  desires  of  the  other,  in  return  for  counter 
support. 

The  evil  shows  itself  most  of  all,  perhaps,  through  the 
influence  exerted  by  localities  or  by  special  interests  in 
different  localities.  We  have  noted  this  particularly 
in  the  case  of  the  protective  tariff.2  And  just  as,  in  the 
case  of  the  tariff,  congressional  representatives  from 

1  Fuller,  American  Waterways  and  the  Pork  Barrel ,  loc.  cit. 

2  Chapter  VI  (of  Part  II),  §  6. 


180  ECONOMIC  ADVANTAGES  OF  COMMERCE 


different  states  and  districts  desire,  each,  to  get  or  keep 
a  high  tariff  for  the  goods  produced  in  his  district,  what¬ 
ever  the  effect  on  the  common  weal,  and  sometimes 
inconsistently  with  their  party  platforms,  so  these  repre¬ 
sentatives  desire  appropriations  of  money  to  improve 
waterways,  each  for  his  own  district,  even  though  the  cost 
to  the  country  as  a  whole  far  exceeds  the  benefit,  and 
even  though  each  district  suffers  more  from  its  forced 
contributions  to  improvements  in  other  districts,  than 
it  gains.  There  is,  consequently,  a  process  of  “  log¬ 
rolling,  ”  so-called,  in  which  A  votes  for  B’s  project  in 
return  for  support  of  his  own ;  and  the  ultimate  result 
is  an  appropriation  or  set  of  appropriations  having  no 
consistency  and  involving  general  loss. 

Each  Congressman  thus  acting,  feels  that  he  is  gaining 
favor  with  his  constituents.  The  persons  interested  in 
local  waterway  constructions  make  representations  to 
him  regarding  the  importance  of  them.  He  feels  that 
the  people  of  his  district  are  not  concerned  primarily  in 
having  him  act  the  part  of  a  wise  and  conscientious 
legislator,  careful  not  to  waste  the  nation’s  resources, 
but  that  they  are  concerned  rather  in  having  him  “do 
something”  for  them.  If  he  succeeds  in  getting  what  is 
desired,  the  newspapers  of  the  district  publish  the  fact 
that,  through  his  influence,  Congress  has  been  led  to  ap¬ 
propriate  a  sum  to  improve  navigation  on  the  local  stream 
or  to  deepen  the  local  harbor.  The  fault  is  not  alone 
that  of  the  Congressman  who,  under  such  circumstances, 
does  the  thing  which  he  believes  his  constituents  desire, 
but  is  also  largely  the  fault  of  those  constituents  them¬ 
selves,  whose  selfish  local  interests  overshadow  in  their 
minds  the  greater  interests  of  the  nation  of  which  they  are 
a  part,  and  whose  limited  intelligence  will  not  let  them  see 


ENCOURAGEMENT  OF  TRANSPORTATION  181 


that  the  system  practised  is  likely,  in  the  end,  to  hurt 
more  than  to  help  even  their  own  welfare. 

It  would  seem,  then,  that  a  reform  which  would  go  to 
the  root  of  the  difficulty  must  not  only  insist  upon  the 
attempt  to  charge  users  rather  than  taxpayers,  for  facil¬ 
ities  provided,  but  must  also  insist  that  the  entire  first 
cost  and  risk  of  constructing  these  facilities  shall  not  fall 
upon  the  nation  as  a  whole.  If  government  expenditure 
rather  than  private  investment  is  thought  to  be  necessary 
to  improve  certain  waterways,  at  least  the  government 
expenditure  and  risk  should  be  partly  borne  by  localities 
most  directly  concerned.  If  such  localities  will  not 
support  certain  improvements,  themselves,  they  should 
not  expect  the  nation  to  do  so.  If  the  nation  refuses  to 
bear  the  burden  alone,  but  insists,  always,  upon  local  aid, 
there  will  be  far  less  pressure  for  Federal  appropriations, 
and  many  wasteful  expenditures  will  be  avoided.1 

§  7 

Subsidies  to  Railroad  Building 

The  subsidizing  of  transportation,  by  government, 
has  extended,  in  the  United  States  (not  to  mention 
other  countries),  to  railroads  also.  The  railroads  of  the 
United  States  have,  it  is  true,  been  built  pretty  largely 
with  private  capital,  but  they  have  also  received  aid 
from  the  national  government,  from  many  of  the  states, 
and  even  from  county  and  city  governments.  The 
states  and  local  governments,  in  some  instances,  invested 
in  railroad  securities,  so  enabling  the  roads  to  get  capital 

1  Cf.  Preliminary  Report  of  National  Waterways  Commission,  pp.  19,  20 
(Final  Report,  pp.  81,  82).  See  also  Report  of  Commissioner  of  Corporations 
on  Transportation  by  Water  in  the  United  States,  Part  I,  pp.  8,  59,  for  reference  to 
European  practice. 


1 82  ECONOMIC  ADVANTAGES  OF  COMMERCE 


which,  perhaps,  private  persons  would  have  been  less 
ready  to  provide.  But  the  Federal  government,  in  addi¬ 
tion  to  making  loans,  made  very  extensive  land  grants  to 
companies  constructing  numerous  desired  lines,1  chiefly 
in  the  less  densely  settled  parts  of  the  country,  the  West 
and  Southwest.  The  grants  made  between  1850  and 
1871  turned  over  to  the  railroad  companies  about  159 
million  acres  of  the  public  domain,  an  area  exceeding 
five  states  the  size  of  Pennsylvania.2  So  far  as  the  land 
grant  policy  was  based  on  military  conditions,  we  cannot 
judge  it  on  economic  grounds  alone.  But  so  far  as  it 
can  be  regarded  as  a  commercial  policy,  it  can  be  judged 
in  the  fight  of  commercial  principles. 

We  shall  not,  of  course,  be  able  to  decide,  absolutely, 
whether  the  land  grants  and  other  government  aid  to 
the  railroads  actually  decreased  the  total  of  national 
wealth.  So  to  decide,  we  should  have  to  know  not  only 
what  has  happened,  but  just  what  would  have  happened 
if  business  and  transportation  development  had  taken 
its  natural  course.  But  we  can  lay  down  general  prin¬ 
ciples  of  usual  application,  which,  in  the  long  run,  are 
apt  to  be  safest  to  follow. 

To  begin  with,  it  must  be  admitted  that  there  is  such 
a  thing  as  undesirable  transportation.  The  labor  and 
capital  of  a  country  should  be  applied  in  order  of  pref- 

1  See,  on  this  subject,  Haney,  A  Congressional  History  of  Railways  in  the  United 
States,  Vol.  II.  The  Railway  in  Congress :  1850-1887,  Madison,  Wis.  (Demo¬ 
crat  Printing  Co.,  State  Printer),  1910,  Chs.  II,  III.  Also  Sanborn,  Congres¬ 
sional  Grants  of  Land  in  Aid  of  Railways,  Madison  (Bulletin  of  the  University 
of  Wisconsin),  1899,  Chs.  VI,  VII.  A  good  brief  account  is  in  Johnson,  American 
Railway  Transportation,  2d  revised  edition,  New  York  (Appleton)  1000 
Ch.  XXII. 

2  Not  including  land  forfeited  by  failure  to  conform  to  conditions.  The 
granting  of  the  mere  rights  of  way  might  be  regarded  as  analogous  to  the  grant¬ 
ing  of  farms  to  actual  settlers.  But  the  granting  of  millions  of  acres  additional 
cannot  be  so  regarded. 


ENCOURAGEMENT  OF  TRANSPORTATION  183 


erence  to  different  industries  according  to  their  relative 
importance,  according  to  the  relative  need  for  them. 
In  other  words,  the  people  should  devote  their  efforts  to 
the  lines  which  pay  best.  It  may  be  said  that  the  people 
living  in  the  Middle  West  and  Far  West,  where  railroad 
building  was  encouraged  by  government  more  than  in 
the  East,  desired  railroads  as  a  means  of  reaching  eastern 
markets.  But  the  mere  existence  of  railroads  leading  to 
markets  does  not  in  itself  mean  greater  prosperity,  since 
the  benefits  so  received  may  be  appreciably  less  than  if 
the  same  capital  were  invested  in  some  kind  of  produc¬ 
tive  enterprise  for  immediate  local  needs.  Unless  the 
trade  made  possible  by  a  railway  brings  as  much  wealth 
and  prosperity  as  could  have  been  had  by  foregoing  the 
trade  and  producing  more  locally,  unless,  that  is,  as 
much  of  desired  wealth  is  produced  by  the  railway  as 
would  be  produced  were  the  labor  and  capital  applied 
instead  to  the  farms  and  ranches,  to  building  houses, 
making  furniture,  etc.,  the  building  of  the  road  is  not 
economy  for  th^  community.  If  a  railroad  when  con¬ 
structed  will  yield  the  people  of  a  community  a  benefit 
equivalent  to  what  the  same  investment  would  yield  in 
another  line,  then  those  who  receive  this  benefit  can 
afford  to  pay,  for  the  use  of  the  railroad,  a  proper  return 
on  the  capital  invested.  If  they  cannot  afford  to  pay 
such  a  return,  it  must  be  because  they  are  not  receiv¬ 
ing  a  correspondingly  valuable  service  and,  therefore,  it 
must  be  that  the  capital  invested  in  the  railroad  is  not 
producing  the  value  which  it  might  have  produced  if 
invested  otherwise. 

If  the  territory  through  which  a  railroad  is  desired  is 
sparsely  settled  and  would  offer  but  small  traffic  in  pro¬ 
portion  to  trackage,  thus  only  very  partially  utilizing 


184  economic  advantages  of  commerce 


the  plant  of  the  railroad,  then  high  charges  would  be 
required,  in  order  that  the  railway  plant  might  pay  to 
the  owners  the  average  rate  of  profit  on  investment. 
But  high  charges  may  be  as  serious  preventives  of  reach¬ 
ing  markets  as  absence  of  railroads  leading  to  markets. 
If,  therefore,  only  small  traffic  can  be  hoped  for,  it  may 
be  truer  economy  for  the  territory  concerned  and  the 
various  communities  in  it,  to  be  more  self-sufficient,  to 
depend  more  exclusively  on  natural  waterways,  or  to 
carry  goods  by  using  horses  and  vans,  than  to  build  a 
railroad. 

The  people  of  a  given  section  of  the  country  may 
think  that  they  gain  nothing  by  having  an  incompletely 
utilized  railroad,  if  they  have  to  pay,  in  high  freight  and 
passenger  rates,  interest  on  its  cost.  They  may  not  be 
prepared  to  patronize  such  a  road,  feeling  that  the  ser¬ 
vice  is  not  worth  the  charges.  Yet  if  the  road  is  paid 
for  in  part  by  government  aid,  even  though  they  have  to 
pay  the  taxes  that  make  the  aid  possible,  they  may  de¬ 
lude  themselves  into  thinking  that  they  are  gainers  by 
having  the  railroad.  Nevertheless,  the  people  are  pay¬ 
ing  for  the  service  rendered  just  as  surely  by  this 
method  as  by  the  other,  and  if  it  is  unprofitable  for  them 
to  pay  the  amount  in  the  one  way,  it  is  unprofitable  to 
pay  it  in  the  other.  The  chief  difference  is  that  if  govern¬ 
ment  supports  the  enterprise  without  receiving  any  cor¬ 
responding  return,  the  cost  of  the  service  rendered  is 
paid  for  by  the  people  without  any  regard  to  the  propor¬ 
tionate  benefits  received. 

If  the  assistance  is  by  grants  of  land,  the  essential 
principle  of  the  policy  is  the  same.  The  public  domain 
belongs  to  the  whole  people.  It  rests  with  them  to  give 
it  to  settlers,  to  keep  it  as  forest  reserve  and  for  other 


ENCOURAGEMENT  OF  TRANSPORTATION  185 


purposes,  or  to  secure  money  revenue  by  selling  it.  To 
contribute  it  to  railroad  companies  is  as  much  a  cost  as 
to  contribute  the  equivalent  in  money.1 

As  a  consequence  of  the  land  grant  policy,  capital 
was  diverted  to  transportation  purposes  which  might 
have  yielded  larger  returns  in  agriculture  or  in  manufact¬ 
ures.  In  so  far  as  the  policy  had  this  effect,  it  lessened 
rather  than  increased  national  prosperity.  Because  of 
the  land  grant  policy,  also,  population  tended  to  be  di¬ 
verted  towards  the  Middle  and  Far  West,  while  there 
was  still  room  in  the  East,  South,  and  Central  states. 
As  a  result  of  this  diffusion  of  population,  goods  were 
probably  carried  by  rail  over  longer  distances  than  would 
have  been  necessary  had  population  been  for  a  time 
more  concentrated  and  had  its  extension  westward  been 
more  gradual.  Had  the  westward  movement,  except 
that  by  water  to  the  Pacific  coast,  been  slower,  a  shorter 
connection  could  have  been  kept  by  the  near  frontier 
with  the  more  densely  settled  parts  of  the  country,  and 
the  necessity  of  long  hauls  of  meagre  traffic  through 
undeveloped  sections  could  have  been,  in  part,  avoided. 
It  is  doubtless  true  that  some  sections  of  the  West  are 
exceptionally  rich  and  fertile,  as  some  are  exceptionally 
mountainous  or  arid.  That  the  former  should  event¬ 
ually  hold  a  large  population  was  both  unavoidable  and 
desirable.  But  that  the  movement  westward  should 
have  been  artificially  hastened,  at  the  cost  of  millions 
of  acres  of  the  public  domain,  at  the  cost  of  diverting 
labor  from  other  industries  into  transportation,  at  the 
cost  of  unnecessary  distances  in  transportation,  and  at  the 
cost  of  building  railroads  in  advance  of  traffic,  ought  not 
to  be  too  readily  taken  for  granted. 

1  See,  however,  considerations  later  in  this  section,  especially  in  footnote. 


186  ECONOMIC  ADVANTAGES  OF  COMMERCE 


As  some  parts  of  the  country  presumably  gained  by 
the  policy,  so  other  parts  probably  lost  wealth.  Many 
of  the  eastern  farmers,  for  instance,  found  themselves 
disadvantaged  by  competition  with  producers  of  the 
West.  So  far  as  western  farmers,  by  virtue  of  natural 
advantages,  were  able  to  undersell  the  farmers  of  the 
East,  the  result  was  economical  and  beneficial.  But 
so  far  as  western  farmers  were,  in  effect,  given  bounties, 
by  having  transportation  provided  in  part  at  national 
expense,  the  result  may  very  well  have  been  a  national 
loss.  If  the  prosperity  of  the  government-aided  western 
farmer  was  increased,  that  of  the  eastern  farmer  was 
decreased.  If  the  value  of  western  land  was  raised,  that 
of  eastern  land  was  lowered.1 

One  type  of  municipal  or  local  aid  deserves  particular 
mention.  This  is  aid  which  is  made  conditional  on  the 
choice  of  a  route  through  the  town  or  city  giving  it. 
Such  aid  introduces  an  uneconomical  basis  (from  the 
social  point  of  view)  of  calculation  into  the  choice  of  a 
route.  The  route  selected  is  less  apt  to  be  the  one  which, 
all  matters  of  traffic  and  expense  considered,  is  most 
profitable,  and,  therefore,  socially  most  desirable,  but  is 
apt,  rather,  to  be  a  route  favored  by  the  largest  promises 
of  local  aid. 

1  To  the  argument  that  the  government  so  raised  the  value  of  the  remainder 
of  its  own  land,  it  can  be  answered  that  it  is  not  the  business  of  a  government 
to  depreciate  the  land  of  citizens  in  order  to  raise  the  value  of  public  land.  If 
the  principle  that  land  rent  is  largely  a  social  product  and  belongs  mainly  to 
the  whole  people,  were  commonly  accepted,  depreciating  some  land  to  raise  the 
value  of  other  land  would  appear  clearly  to  be  uneconomical.  It  is  probable, 
in  the  case  under  discussion,  that  enough  railroads  would  soon  have  been  built, 
and  that  the  government,  even  in  the  narrow  sense  here  used,  lost  more  than  it 
gained  by  making  the  grants. 


ENCOURAGEMENT  OF  TRANSPORTATION  187 

§  8 

Summary 

Let  us  now  briefly  restate  the  principles  set  forth  in 
this  chapter,  regarding  government  interference  with 
and  encouragement  of  transportation.  Navigation  laws 
were  first  considered.  These  laws  attempt  to  develop 
the  national  merchant  marine  by  excluding  foreign  ships 
from  certain  trade.  The  United  States  excludes  foreign 
vessels  from  the  coasting  trade.  Considered  from  the 
purely  economic  viewpoint,  these  laws  are  analogous 
to  protection,  and  for  similar  reasons  they  are  economi¬ 
cally  undesirable. 

Shipping  subsidies  are  in  the  nature  of  bounties.  In 
general  it  may  be  said  that  they  are  without  economic 
justification.  It  may  be  defensible,  however,  or  even 
desirable,  to  make  definite  payments  to  certain  lines  of 
ships,  in  order  to  have  a  claim  to  vessels  as  naval  reserves. 
Subsidies  may  be  indirect,  as  when  certain  privileges  are 
given  to  a  nation’s  own  merchant  vessels,  at  the  tax¬ 
payers’  expense,  which  are  denied  to  the  ships  of  other 
nations.  The  purpose  of  discriminating  subsidies,  direct 
or  indirect,  is  not  so  much  to  increase  commerce  as  to 
have  it  carried  in  vessels  of  the  subsidy-paying  country. 

Facilities  for  transportation  are  frequently  provided 
by  government  at  the  taxpayers’  expense.  These  tend 
to  stimulate  commerce  which  is  not  worth  the  expense 
borne,  and  which  could  not  pay  this  expense.  Such  a 
policy  is  unfair  to  the  general  tax-paying  public  and  vio¬ 
lates  the  principle  that  those  who  gain  by  any  facilities 
should  be  the  ones  to  pay  for  them.  Such  provision  of 
commercial  facilities  at  public  expense  would  have  been 
the  carrying  out  of  the  plan  to  allow  United  States  coast- 


188  ECONOMIC  ADVANTAGES  OF  COMMERCE 


ing  vessels  to  use  the  Panama  Canal  free.  Such  provi¬ 
sion  of  facilities  at  public  expense  is  the  plan  to  have  the 
Erie  Canal  forever  free  from  tolls.  Sections  of  the  country, 
or  of  the  state  of  New  York,  which  have  little  or  nothing 
to  gain  by  the  creation  of  these  facilities,  would  have 
been,  or  will  be,  taxed  that  other  sections  might  use 
them  toll  free.  The  Federal  policy  of  harbor  and  river 
improvement  is  also  a  policy  of  subsidizing  commerce, 
and  is,  therefore,  popular  with  and  favored  by  the  in¬ 
terests  subsidized.  Like  the  protective  tariff  policy, 
the  policy  of  subsidizing  water  transportation  is  partly 
the  result  of  bargaining  between  representatives  of  differ¬ 
ent  districts,  each  trying  to  get  something  at  the  general 
expense.  The  British  system  of  a  Public  Harbor  Trust 
avoids  private  monopoly  of  facilities,  but  makes  the 
traffic  using  the  facilities  provided,  pay  for  them. 

Land  grants  to  railways,  like  other  aids  to  water  trans¬ 
portation,  are  indirect  subsidies  given  to  commerce,  and, 
as  such,  are  open  to  objections.  The  general  rule  which 
it  is  safest  for  government  to  follow,  is  that  those  who 
chiefly  benefit  by  facilities  provided  for  commerce  should 
chiefly  pay  for  them,  rather  than  that  these  facilities 
should  be  paid  for  by  the  people  in  general,  without 
regard  to  proportionate  benefits  received. 


PART  III 


THE  TRANSPORTATION  COSTS  OF  COMMERCE 


CHAPTER  I 


The  Cost  of  Transportation 


Preliminary  Remarks  on  the  Expenses  of  Railroads 


Before  taking  up  a  consideration  of  transportation 
rates,  or  of  economical  versus  uneconomical  carriage  of 
goods,1  we  may,  with  advantage,  analyze  transportation 
costs.  We  shall  begin  by  classifying  and  discussing  the 
expenses  of  railroad  companies.2  Scarcely  any  of  the 
expenses  which  a  railroad  company  has  to  meet  can  be 
said  to  vary  in  exact  proportion  with  the  traffic.  Even 
the  cost  of  fuel  and  the  wages  of  engineers  and  trainmen 
do  not  vary  in  exact  proportion  with  amount  of  goods 
carried,  or  in  exact  proportion  with  the  number  of  cars 
or  the  number  of  trains  hauled.  But  it  is  probably  not 
widely  false  to  state  that  such  expenses  as  these  will 
vary,  in  any  given  period,  about  as  the  number  of  trains 

1  Except  as  such  carriage  of  goods  has  already  been  considered  in  Part  II, 
Chapter  VIII. 

2  The  writer  has  found  particularly  helpful,  though  he  has  not  followed  it 
throughout,  the  analysis  of  ton  mile  cost  in  Woodlock’s  Anatomy  of  a  Rail¬ 
road  Report  and  Ton  Mile  Cost ,  New  York  (S.  A.  Nelson),  1900,  Chapters 
I  to  V,  inclusive,  of  Ton  Mile  Cost.  See  pp.  86  and  87  of  Woodlock  for  sum¬ 
mary  of  classification.  On  the  difficulty  of  finding  any  uniform  and  entirely 
satisfactory  basis  for  the  allocation  of  railroad  expenses  on  different  roads, 
even  between  freight  and  passenger  service,  see  Hooper,  Railroad  Accounting, 
New  York  (Appleton),  1915,  Chapter  XV. 


3 


4  TRANSPORTATION  COSTS  OF  COMMERCE 


times  the  average  number  of  miles  a  train  is  taken  during 
that  period.  If  we  bear  in  mind  that,  within  the  limits 
permitted  by  reasonable  frequency  of  trains,  the  number 
of  cars  to  a  train  will  be,  on  the  whole,  the  best  paying 
(i.e.  the  length  of  train  will  be  the  best  paying),  then 
we  may  say  that  these  expenses  (for  fuel,  wages  of 
engineers,  etc.)  vary,  in  a  considerable  degree,  as  traffic 
varies.  Other  railroad  expenses,  however,  seem  to 
have  much  less  relation  and,  in  some  cases,  almost 
no  relation  to  the  quantity  of  transportation  business 
done. 

By  a  parallel  argument  it  may  be  shown  that  no  ap¬ 
preciable  amount  of  a  railroad’s  expenses  can  be  exactly 
allocated  to  (regarded  as  particularly  caused  by)  any 
special  traffic.  For  example,  suppose  coal  and  live 
stock  to  be  carried  in  the  same  train  load.  Much  of 
the  expense  of  carrying  is  a  joint  expense,  e.g.  the  cost 
of  fuel  and  the  wages  of  engineer  and  fireman.  If  the 
coal  and  the  live  stock  are  carried  in  the  same  train, 
it  will  appear  difficult,  if  not  impossible,  to  determine 
how  much  of  the  cost  of  running  the  train  is  a  cost  of 
carrying  coal,  and  how  much  is  a  cost  of  carrying  live 
stock.  Yet  when  train  loads  are  homogeneous,  made  up, 
each,  entirely  of  one  kind  of  goods,  some  expenses  may 
be  allocated,  such  as  fuel  cost,  engineer’s  wages,  etc. 
It  can  be  determined,  approximately,  what  is  the  cost 
per  train  load  of  hauling  coal,  and  what  is  the  train 
load  cost  of  hauling  live  stock.  From  this  we  may 
deduce  the  cost  per  ton  mile  of  hauling  each.  But 
there  are  other  and  more  general  railroad  expenses 
which  cannot  thus  easily  be  allocated,  or  attributed  to 
different  kinds  of  traffic,  any  more  than  they  can  be 
said  to  vary  in  proportion  to  traffic.  What  is  needed 


THE  COST  OF  TRANSPORTATION 


5 


is  a  careful  analysis  of  the  expenses  of  a  railroad,  with 
a  view  to  determining  the  relation  which  these  expenses 
have  to  amount  and  kinds  of  traffic,  and  the  influence 
which  they  have  and  ought  to  have  on  rates. 

§  2 

Classification  of  the  Expenses  of  Rail  Transportation 

In  attempting  such  an  analysis,  we  may  divide  the 
expenses  of  a  railroad  into  four  classes,  in  rough  pro¬ 
portion  to  the  relative  exactness  with  which  these  ex¬ 
penses  vary  as  traffic  varies,  and  in  proportion,  also, 
as  they  are  easily  and  clearly  attributable  to  different 
kinds  or  to  different  lots  of  traffic.  The  first  class  of 
expenses  of  a  railroad  company  includes  all  expenditures 
for  the  production  of  train  mileage,  train  mileage  being 
defined  as  the  total  number  of  trains  run  during  a  given 
period,  times  the  average  number  of  miles  a  train  is  run. 
The  expenses  in  this  first  class  will  be  found  to  be  the 
most  variable  and  apportionable  of  any.  Second,  there 
are  terminal  expenses,  which  are  variable  in  proportion 
to  volume  of  traffic  and  are  in  some  degree  apportionable, 
but  which  have  no  relation  to  the  distance  goods  are 
carried.  Third,  there  are  the  general  expenses,  or  pre¬ 
paratory  and  complementary  expenses,  which  are  slightly 
variable  within  wide  limits,  but  which  are  not  likely  to 
vary  much,  if  at  all,  with  small  changes  in  the  volume 
of  business,  and  which  cannot,  to  any  considerable 
extent,  be  allocated,  or  attributed  to  any  special  traffic. 
The  fourth  class  is  made  up  of  the  so-called  fixed 
charges  (or  the  sunk  costs),  which,  once  the  road  has 
been  built,  are  not  at  all  variable  as  traffic  changes, 
or  at  all  attributable  to  different  parts  of  the  total 


6  TRANSPORTATION  COSTS  OF  COMMERCE 


business  done.1  Let  us  consider  these  four  classes  of 
railroad  expenses  in  the  above  order. 

Expenses  for  the  production  of  train  mileage  include 
some  half  dozen  different  subclasses  of  expense.  First, 
there  is  the  cost  of  production  of  locomotive  power. 
This  cost  includes  wages  of  engineers  and  firemen,  value 
of  coal  burned,  of  oil  and  tallow  used,  etc.  Second, 
there  are  expenses  for  maintenance  of  equipment,  such 
as  repairs  of  engines  and  cars.  The  third  item  among 
expenses  for  production  of  train  mileage  is  a  part  of  the 
cost  incident  to  maintenance  of  way.  Renewals  of  rails 
and  renewals  of  switches  and  of  rail  fastenings,  so  far  as 
they  are  due  to  wear  and  hence  depend  upon  the  num¬ 
ber  of  train  miles,  are  maintenance  of  way  expenses 
which  must  be  classed  as  being  for  the  production  of  train 
mileage.  The  same  thing  is  to  be  said,  in  part,  of  ex¬ 
penses  for  tie  renewals.  In  part,  these  renewals  are 
necessitated  by  weather  conditions  and  are  not  related 
to  the  use  made  of  the  tracks,  but  in  part  they  depend 
upon  this  use.  This  third  item  includes  also  such  repairs 
of  roadbed  as  are  not  due  to  weather  and  floods,  and 
includes,  further,  a  certain  amount  of  bridge  repairs. 
Fourth,  the  expenses  for  the  production  of  train  mileage 
include  the  cost  of  train  service  and  supplies.  This 
means  particularly  the  wages  of  trainmen,  oiling,  and, 
in  the  case  of  passenger  trains,  heating  and  lighting. 
Fifth,  there  is  the  cost  of  superintendence  and  super¬ 
vision  in  the  movement  of  trains,  a  cost  which  depends 
in  large  part  upon  the  number  of  trains  to  be  run  and  the 
average  distance  they  are  to  be  run.  Other  expenses 
might  perhaps  be  mentioned,  which  pertain  particularly 

1  See,  however,  later  paragraphs  of  this  section  (2),  in  which  the  possible  re¬ 
quirement  of  additional  construction  is  discussed. 


THE  COST  OF  TRANSPORTATION 


7 


to  the  production  of  train  mileage,  but  those  here  given 
are  fairly  inclusive,  and  will  at  least  serve  for  illus¬ 
tration. 

The  expenses  above  given  incident  to  the  production 
of  train  mileage  are  the  operating  expenses  which  vary 
in  some  approximate  proportion  with  the  trains  moved 
times  the  average  number  of  miles,  i.e.  with  train  mileage. 
They  do  not,  however,  vary  in  exact  proportion  to  the 
number  of  trains  times  the  average  number  of  miles 
that  trains  are  run,  since  trains  are  not  all  of  the  same 
length  or  loaded  with  equally  heavy  cargoes.  The  cost 
of  running  long  and  heavily  loaded  trains  is  greater  for 
the  same  distance  than  the  cost  of  running  less  heavily 
loaded  and  shorter  trains.  Yet  it  is  not  greater  in  pro¬ 
portion  to  the  larger  amount  of  goods  carried,  until  the 
train  load  of  maximum  efficiency  has  been  reached.1 
This  train  load  will  be,  where  circumstances  favor,  the 
largest  which  the  most  efficient  and  economical  type  of 
engine  for  the  purpose  can  conveniently  draw.  The 
cost  in  fuel  and  labor  of  drawing  such  a  train  load, 
obviously  will  not  be  twice  as  great  as  the  cost  of  draw¬ 
ing  the  same  train  loaded  to  but  half  its  capacity  or  of 
drawing  a  train  of  half  the  length.  The  expense  of 
production  of  train  mileage  does  not,  therefore,  increase 
as  rapidly  as  business  increases,  except  in  the  case  of  a 
road  (or  part  of  a  road)  whose  volume  of  business  is 
already  so  great  as  to  permit  the  train  load  of  maximum 
economy.  Where  traffic  is  not  heavy,  the  frequency  of 
service  required  for  public  convenience  makes  impossible 
the  larger  trains  and  heavier  loading  which  otherwise 

1  The  special  case  of  traffic  taken  to  fill  cars  which  must  otherwise  be  re¬ 
turned  empty  to  their  starting  point  is  discussed  in  Chapter  V  (of  Part 
HI),  §  7. 


8  TRANSPORTATION  COSTS  OF  COMMERCE 


would  be  attempted.  The  first  class  of  expenses, 
therefore,  that  for  the  production  of  train  mileage, 
increases  as  the  amount  of  traffic  increases,  but  does 
not  increase,  on  the  average  road,  as  rapidly  as  traffic 
increases. 

The  second  class  is  terminal  expenses.  These,  too, 
may  properly  be  regarded  as  operating  expenses.  They 
are  the  expenses  for  loading  and  unloading  freight,  when 
this  is  done  by  the  railroad  company  transporting  it  and 
not  by  the  consignor  and  consignee.  They  include, 
also,  expenses  of  switching,  expenses  for  making  up 
trains,  expenses  incident  to  repairing  terminals,  so  far 
as  this  repairing  is  occasioned  by  the  use  of  these  ter¬ 
minals,  and,  in  general,  expenses  incident  to  collection 
and  handling  of  freight  and  passengers  at  terminals 
proper  and  at  intermediate  points.  The  amount  of 
freight  and  the  number  of  passengers  carried  affect 
these  expenses,  though  probably  not  proportionally,  but 
the  distances  the  freight  and  passengers  are  carried  do 
not  affect  them. 

General,  or  preparatory  and  complementary,  expenses 
constitute  the  third  great  class  of  costs.  These  general 
expenses  we  may  subdivide,  in  the  main,  into  two  sub¬ 
classes.  First,  there  are  a  part  of  the  expenses  for 
general  direction  and  supervision,  for  clerical  work,  for 
soliciting  traffic,  etc.,  which  would  not  need  to  be  in¬ 
curred  if  a  railroad  company  should  elect  to  do  no  busi¬ 
ness  at  all,  but  which,  nevertheless,  vary  comparatively 
little  even  with  marked  increases  and  decreases  of  traffic, 
and  which,  with,  perhaps,  the  partial  exception  of  solicit¬ 
ing  expenses,  can  be  allocated  hardly  at  all,  i.e.  cannot 
be  said  to  be  especially  incurred  for  this  or  that  part  of 
the  traffic.  Such  expenses  are  among  those  sometimes 


THE  COST  OF  TRANSPORTATION 


9 


described  as  joint  costs  1  of  all  the  traffic.  Second,  there 
are  many  expenditures  for  maintenance  of  plant,  such 

1  As  by  Taussig  in  the  Quarterly  Journal  of  Economics ,  1891,  Vol.  V,  pp. 
438-465.  Pigou,  in  his  Wealth  and  Welfare,  London  (Macmillan  &  Co.),  1912, 
pp.  215-219,  criticizes  the  view  that  railway  transportation  is  essentially  a 
business  of  joint  costs.  See,  also,  discussion  between  Professors  Taussig  and 
Pigou  in  the  Quarterly  Journal  of  Economics  for  February,  May,  and  August, 
of  1913.  While  the  method  of  approaching  the  theory  of  rates,  in  this  book, 
may  appear  to  be  essentially  that  of  the  joint  cost  theorists,  the  conclusions 
reached  have  been  carefully  qualified  in  the  text  and  in  footnotes,  and  it  is  hoped 
that  any  substantial  basis  for  criticism  on  that  score  has  been  avoided.  It 
must  be  admitted  that  the  carrying  of  (say)  two  commodities,  e.g.  wheat  and 
coal,  by  railroad,  is  not  a  case  of  joint  cost  in  quite  the  same  sense  as  the  pro¬ 
duction  of,  for  example,  beef  and  hides.  The  transportation  of  the  wheat  and 
coal  is  a  case  of  joint  cost  (if  we  wish  to  use  that  expression),  only  in  the  sense 
that  certain  expenses  do  not  vary  proportionately  whether  traffic  (within  wide 
limits)  is  large  or  small,  only,  that  is,  in  the  sense  that  the  plant  which  is  con¬ 
structed  primarily,  perhaps,  to  carry  the  wheat,  cannot  be  fully  utilized  in 
transporting  the  wheat  and  may  also  be  used,  without  correspondingly  greater 
expense,  to  carry  the  coal.  But,  supposing  the  size  of  railroad  plant  of  maximum 
economy  to  have  been  reached,  a  larger  and  larger  demand  for  the  transportation 
of  wheat  would  not  increase  —  it  would,  rather,  decrease  —  the  possible  supply 
of  the  service  of  transporting  coal.  So  long  as  the  plant  was  but  partially  utilized 
in  transporting  the  wheat,  it  might  be  possible  to  carry  the  coal  at  very  low 
rates,  because  the  relatively  constant  expenses  were  chiefly  covered  by  the 
charge  made  for  transporting  the  wheat.  But  when  the  plant  came  to  be  more 
fully  utilized,  with,  perhaps,  a  possibility  of  being  completely  utilized,  in  trans¬ 
porting  the  wheat,  the  transportation  of  coal  would  be  a  competitive  rather  than  a 
complementary  use  of  the  plant ;  and  even  before  the  capacity  of  the  plant  was 
put  to  the  test  by  traffic  all  of  which  was  able  to  pay  its  proportionate  share 
towards  the  general  expenses  and  fixed  charges,  the  increased  demand  for  the 
transportation  of  wheat  might  somewhat  raise  the  rates  on  the  transportation  of 
coal.  The  production  of  beef  and  hides  is  a  typical  case  of  joint  cost.  An 
increased  demand  for  beef  tends  to  raise  its  price  and  to  encourage  its  produc¬ 
tion.  Such  increased  production  of  beef  necessarily  involves  the  first  stage  of, 
and  a  partial  meeting  of  the  expenses  of,  an  increased  production  of  hides,  and 
so  tends  to  lower  the  price  of  hides.  (See  Fisher,  Elementary  Principles  of 
Economics,  New  York  —  Macmillan  — ,  1912,  p.  349.)  Somewhat  analogously, 
the  transportation  of  wheat,  when  this  requires  the  preliminary  construction  of 
a  railroad  plant  which  cannot  be  completely  utilized  by  carrying  wheat  only, 
may  involve  the  first  stage  of,  and  a  partial  meeting  of  the  expenses  of,  the  trans¬ 
portation  of  coal,  and  so  may  tend  to  make  possible  the  transportation  of  coal 
at  very  low  rates.  But  a  further  increase  in  the  transportation  of  wheat  would 
decrease  rather  than  increase  the  facilities  which  might  be  available  for  the 
transportation  of  coal  and  would  be  likely  to  raise  the  rates  for  such  transporta¬ 
tion. 


IO  TRANSPORTATION  COSTS  OF  COMMERCE 


as  renewals  of  ties,  repairs  of  roadbed,  etc.,  which  are 
not  dependent  upon  the  amount  of  train  mileage,  which 
have,  perhaps,  very  little  relation  to  the  amount  or  kind 
of  traffic,  but  which  are  necessitated  by  weather  condi¬ 
tions  or  other  extraneous  circumstances,  and  which  must 
be  met  to  a  degree,  if  a  railroad  company  intends  to  do 
any  business  at  all.1  Not  only  are  these  expenses  of  the 
third  class  not  dependent  upon  amount  of  traffic,  but 
they  cannot  be  allocated  to  different  kinds  of  traffic. 

Fixed  charges  constitute  the  fourth  main  class  of 
costs.2  This  class  includes  interest  on  a  company’s 

1  A  very  great  decrease  of  traffic  might,  of  course,  make  possible  a  decrease  in 
the  administration  expenses  and  an  abandonment  of  part  of  the  plant,  e.g.  one 
of  several  tracks,  with  resultant  saving  of  maintenance  costs.  On  the  other 
hand,  an  increase  of  business  sufficient  to  require  additions  to  the  plant,  e.g. 
additional  trackage,  would  involve  added  expense  for  maintenance  and,  perhaps, 
supervision.  But,  within  wide  limits,  general  expenses  are  largely  independent 
of  the  volume  of  business. 

2  The  Interstate  Commerce  Commission  has,  as  one  of  its  duties,  to  prescribe 
a  system  of  accounting  for  all  interstate  railroads.  In  carrying  out  this  duty, 
it  has  made  a  classification  of  expenses  considerably  different  from  that  above 
described.  (See  Statistics  of  Railways  in  the  United  States,  1910,  pp.  85,  86.) 
Operating  expense  accounts  of  the  railroads  are  made  to  include  items  for : 

I.  Maintenance  of  way  and  structures  (such  as  for  upkeep  of  roadbed  and 
bridges);  this  was  $425,173,389  in  the  year  ending  June  30,  1913,  for  all  the 
railroads  of  the  United  States.  (For  this  and  for  the  following  figures,  see 
Statistics  of  Railways  in  the  United  States,  1913,  pp.  50,  51,  and  52.) 

II.  Maintenance  of  equipment  (upkeep  of  engines,  cars,  etc.);  this  was 
$513,406,662  in  1913. 

III.  Traffic  expenses  (as  those  for  advertising  and  for  soliciting  traffic) ;  in 
1913  this  was  $63,082,500. 

IV.  Transportation  expenses  (such  as  wages  of  engineers,  trainmen,  and 
yardmen  and  cost  of  fuel),  totaling  $1,101,742,932  in  1913. 

V.  General  Expenses  (including  administration,  insurance,  etc.),  amounting 
for  all  the  roads,  in  1913,  to  $79,363,517. 

In  addition  to  these  operating  expenses,  there  are  such  fixed  charges  as 
rentals  (totaling  $133,903,011  in  1913)  and  interest  on  funded  debt  ($380,145,142), 
besides  a  few  minor  deductions  from  revenue. 

This  classification,  however,  though  it  may  be  much  more  practical  for  many 
purposes  of  accounting  and  supervision  than  the  one  which  we  have  followed,  is 
not  equally  significant  in  the  study  of  railway  rate  making.  For  such  operating 
expenses  as  those  pertaining  to  maintenance  of  way  and  structures  and  to  main- 


THE  COST  OF  TRANSPORTATION 


ii 


debt,  rentals  which  it  may  have  obligated  itself  to  pay 
for  the  privilege  of  operating  certain  branch  lines  or 
using  certain  tracks,  and  taxes.  These  expenses  are  the 
least  variable  among  all  the  four  classes.  In  fact,  once 
a  sufficient  trackage  and  other  facilities  have  been  con¬ 
structed,  most  of  them  do  not  vary  at  all  with  changes 
of  traffic.  Whether  traffic  be  large  or  inconsiderable, 
profitable  or  the  reverse,  interest  on  the  debt  must  equally 
be  paid  when  due.  Likewise  it  is  obvious  that  these 
fixed  charges  cannot  be  allocated  to  any  special  part  of 
the  traffic  of  a  road,  cannot  be  said  to  be  incurred  for  the 
sake  of  any  particular  traffic. 

But  it  may  be  objected  that  a  railroad  need  not  have 
much  of  fixed  charges,  that  it  may  have  leased  no  branch 
lines  and  may  have  no  debt,  that  its  capital  may  have 
been  raised  entirely  by  the  sale  of  stock  and  not  at  all 
by  the  sale  of  bonds.  In  that  case,  the  annual  fixed 
charges  would  have  relatively  small  or  no  importance. 
Fixed  charges,  however,  are  in  large  part  but  interest 
on  the  original  cost  of  a  railroad  system.  Interest  paid 
to  bondholders  is  interest  on  cost ;  rentals  are,  in  effect, 
interest  on  cost  (or  estimated  value)  of  branch  and  other 
leased  roads.  If,  then,  there  are  no  fixed  charges,  there 
are  at  least  sunk  costs.  These  sunk  costs  represent  the 


tenance  of  equipment,  as  well  as  the  so-called  “traffic  expenses, ”  are  in  consider¬ 
able  degree  independent  of  amount  of  business.  In  order  to  estimate  the  charac¬ 
ter  of  their  influence  on  rates,  we  may  with  advantage  group  a  part  of  each  of 
these  classes,  for  example,  those  for  maintenance  of  way  so  far  as  dependent  on 
weather  conditions,  with  general  expenses.  Other  maintenance  of  way  expenses, 
dependent  largely  on  amount  of  business,  may  profitably  be  grouped  with  most 
of  the  “transportation  expenses”  under  the  general  title  of  expenses  for  the  pro¬ 
duction  of  train  mileage.  Still  other  expenses,  drawn  from  one  or  more  of  the 
Interstate  Commerce  Commission’s  categories,  may,  with  gain  to  our  study,  be 
classed  as  terminal  expenses.  Thus  we  are  naturally  led  back  to  the  division  of 
railroad  expenses  into  those  for  the  production  of  train  mileage,  terminal  ex¬ 
penses,  general  expenses,  and  fixed  charges. 


12  TRANSPORTATION  COSTS  OF  COMMERCE 


amounts  already  invested  in  terminals,  way,  construc¬ 
tion,  and  equipment,  including,  therefore,  both  necessary 
land  or  space,  and  the  improvements,  structures,  and 
equipment,  which  are  the  products  of  labor.  So  far  as 
the  investment  in  a  railroad  represents  borrowed  capital, 
the  annual  interest  may  be  regarded  as  a  measure  of  the 
investment  made,  and  is  entirely  independent  of  traffic. 
If  none  of  the  capital  was  borrowed  and  no  interest  has 
to  be  paid,  we  may  say  that  the  original  cost  of  building 
the  road  has  been  sunk  once  for  all  and  cannot  be  re¬ 
covered,  however  small  the  traffic,  and  that  it  cannot  be 
attributed  to  any  particular  part  of  the  traffic.  The 
amount  sunk  is  equivalent  to,  and  would  have  been 
exchangeable  for,  the  perpetual  annual  interest  on 
that  amount,  and  vice  versa.  In  either  case,  this  ex¬ 
pense,  once  the  investment  is  made,  is  independent  of 
traffic.1 

Let  it  be  said,  in  this  connection,  that  the  fixed  charges, 
or  the  sunk  costs  of  a  great  railroad  system,  are  usually 
sums  of  great  magnitude.  A  railroad  system  is  a  highly 
capitalistic  enterprise  even  in  a  capitalistic  era.  In 
some  kinds  of  business,  yearly  running  expenses  are  a 
large  part  of  the  total  expenses,  and  the  initial  cost  is 
low.  But  railroading  is  a  business  of  the  opposite  type. 
However  large  are  the  yearly  expenses  of  a  road,  i.e.  the 
expenses  of  doing ,  the  expense  of  becoming  overshadows 
these.  The  predominant  fact  in  a  railroad  company’s 
history  is  building  the  road,  and  the  existence  and  rela- 

1  If  existing  facilities  are  insufficient  for  the  possible  traffic,  and  further  con¬ 
struction  is  necessary,  then,  it  may  be  said,  the  cost  of  such  construction,  or 
the  annual  interest  charge  on  it,  is  occasioned  by  the  additional  traffic  sought, 
and  may  be  attributed  to  this  additional  traffic  which  requires  it.  Yet  here, 
again,  once  the  additional  track  laying  or  other  construction  has  been  done,  the 
sunk  costs,  or  the  fixed  charges  on  the  investment,  are  the  same  whether  the 
additional  traffic  sought  proves  to  be  heavy  or  light. 


THE  COST  OF  TRANSPORTATION 


i3 


tive  magnitude  of  this  primary  cost  has  large  significance 
in  the  problem  of  rate  making. 

It  is  commonly  stated  that  the  railroad  business  is 
subject  to  a  law  of  decreasing  cost,  or,  as  it  is  sometimes 
expressed,  of  increasing  returns.  Taking  the  expenses 
as  a  whole,  they  do  not  increase  in  proportion  to  business. 
But  it  should  be  emphasized  that  the  tendency  to  de¬ 
creasing  proportionate  cost  with  increasing  traffic 
applies,  in  its  full  extent,  only  up  to  the  point  where 
the  railroad  plant  is  most  economically  utilized.  Up  to 
that  point,  increasing  traffic  will  not  correspondingly 
increase  expenses.1  After  that  point  is  reached,  greater 
business  may  require  the  expense  of  new  construction 
and  of  maintenance  of  a  larger  plant  than  before.  Until 
this  larger  plant  is  utilized  nearly  as  fully  as  was  the 
smaller  one,  total  expense  per  unit  of  business  is  likely 

1  This  is  equally  true  of  the  operation  of  other  businesses  up  to  the  point  of 
most  economical  utilization  of  their  fixed  plants.  If  we  reckon  as  fixed  charges 
the  interest  on  the  value  of  a  farm  and  the  cost  of  upkeep,  it  is  true  of  farming. 
So  long  as  additional  men  add  more  to  the  value  of  the  product  than  they  are 
paid  in  wages,  it  is  worth  while  to  utilize  the  land  more  fully,  i.e.  to  cultivate  it 
more  intensively.  Reckoning  interest  and  upkeep  expenses  as  fixed  charges, 
we  would  find  that  the  larger  labor  force  increased  the  product  by  a  greater 
per  cent,  than  the  total  increase  of  expense.  Nevertheless,  the  law  of  diminish¬ 
ing  returns  is  said  to  operate,  when  the  additional  men  no  longer  add  to  the  total 
product,  in  proportion  to  their  number.  Analogously,  a  law  of  diminishing  re¬ 
turns  may  be  said  to  operate  for  additional  labor  (or  labor  and  rolling  stock) 
applied  to  moving  goods  over  a  fixed  railway  plant,  when  the  additional  labor  no 
longer  increases  the  hauling  capacity  of  the  railroad  in  the  same  proportion. 
Yet,  since  the  fixed  plant  need  not  be  increased,  the  greater  business  may  be 
worth  while.  In  the  sense  that  efficiency  and  profits  are  greater  in  proportion  to 
total  expense,  we  have  increasing  returns ;  in  the  sense  that  efficiency  is  (possibly) 
less  in  proportion  to  the  quantity  of  operating  labor,  we  have  diminishing  returns. 
(See  Carver,  The  Distribution  of  Wealth,  New  York  —  Macmillan  —  ,  1904,  pp. 
86-89.)  The  railroad  business  is  much  more  a  business  in  which  a  large  plant  is 
necessary  and  in  which  a  larger  plant  is  more  economical,  than  the  business  of 
agriculture,  or,  perhaps,  than  any  other  business.  And,  in  the  case  of  rail¬ 
roads,  it  is  often  impossible  for  the  size  of  plant  of  greatest  efficiency  to  be  fully 
utilized  by  available  traffic.  Hence,  the  matter  of  utilization  of  plant  has  large 
practical  importance  in  railroad  economics. 


14  TRANSPORTATION  COSTS  OF  COMMERCE 


to  be  greater  than  before.  Whether  the  larger  plant, 
when  thus  fully  utilized,  will  be  more  economical  than 
the  smaller,  depends  upon  whether  the  size  of  plant  of 
maximum  efficiency  has  been  reached.  The  question 
whether  there  is  increasing  economy  from  fuller  utiliza¬ 
tion  of  an  existing  plant,  is  to  be  distinguished  from  the 
question  whether  a  few  larger,  or  more  smaller,  plants, 
bring  greater  results  in  proportion  to  the  same  expendi¬ 
ture.  A  two- track  road  can  carry  more  than  twice  as 
much  traffic  as  a  one-track  road,  since  on  the  latter 
much  more  switching  is  required  and  trains  cannot  follow 
each  other  with  the  same  frequency.  It  is  probable 
that  a  four-track  road  can  accommodate  more  than 
twice  the  traffic  possible  on  a  two-track  road,  since  some 
of  the  tracks  can  be  used  for  fast  freight  and  passenger 
service  and  others  for  slow  freight,  thus  preventing 
interference  of  either  kind  of  service  with  the  other. 
Either  fuller  utilization  of  an  existing  plant  or,  with  still 
further  increase  of  business,  a  correspondingly  complete 
utilization  of  a  larger  and  more  efficient  plant  may, 
therefore,  mean  smaller  cost  per  unit  of  traffic. 

3 

Influence  which  these  Various  Expenses  Have  and  Should 
Have  on  the  Determination  of  Railroad  Rates 

We  turn  now  to  a  consideration  of  the  influences 
which  the  four  classes  of  railroad  expenses  exert  in  the 
making  of  rates.  First,  let  us  consider  expenses  for  the 
production  of  train  mileage.  These  vary  in  a  consider¬ 
able  degree  according  to  the  business  done,  though  they 
increase,  almost  always,  in  a  less  proportion  than  the 
volume  of  business.  If  additional  business  is  taken  by 


THE  COST  OF  TRANSPORTATION 


IS 


a  railroad,  it  will  involve  additional  expense  for  the  pro¬ 
duction  of  train  mileage,  but  usually  not  proportionally 
additional  expense.  If,  therefore,  rates  on  new  traffic 
cannot  be  as  high  as  on  traffic  already  assured,  it  does 
not  follow  that  a  railroad  must  refuse  this  new  traffic. 
But,  since  the  owners  of  a  railroad  do  not  care  to  do  a 
losing  business,  any  particular  traffic  which  cannot  pay 
for  the  extra  train  mileage  expense  incident  to  carrying 
it,  will,  granting  intelligent  management,  be  refused. 

It  is  not  desirable  from  the  point  of  view  of  social  or 
national  economy,  that  such  traffic  should  be  taken. 
For  it  to  be  taken,  means  that  labor  and  capital  is  de¬ 
voted  to  this  task  when  it  could  with  greater  profit  be 
devoted  to  another,  e.g.  agriculture  or  manufacturing. 
Whatever  the  railroad  must  pay  for  this  labor  and  capi¬ 
tal  is  presumably  not  more  than  the  labor  and  capital 
can  produce  of  actual  wealth  or  valuable  service,  if 
otherwise  used  or  employed.  To  say  that  any  traffic 
will  not  pay  for  the  additional  labor  and  capital  (e.g. 
fuel)  required  to  move  it,  is  to  say  that  the  traffic  will 
not  pay  what  the  labor  and  capital  can  produce  in  other 
lines,  and  this  is  to  say  that,  if  the  railroad  takes  such 
traffic,  industry  will  be  in  so  far  diverted  from  some  more 
profitable  to  a  less  profitable  line. 

Second,  let  us  consider  terminal  or  station  expenses. 
These  vary  somewhat  as  the  amount  of  traffic,  but  do 
not  vary  in  proportion  to  the  average  distance  traffic  is 
carried.  Therefore,  on  the  principle  that  a  railway  com¬ 
pany  will  not  accept  freight  offered  for  transportation 
when  to  accept  it  would  lessen  the  railway  company’s 
net  profits,  any  traffic  which  cannot  pay  as  much  towards 
terminal  expenses  as  it  adds  to  these  expenses,  besides 
paying  for  the  train  mileage  costs  which  it  occasions, 


16  TRANSPORTATION  COSTS  OF  COMMERCE 


will  be  refused.  But  these  (terminal)  expenses  will  not 
prevent  a  railroad  from  carrying  any  traffic  for  long 
distances,  even  though  this  traffic  pays  only  the  in¬ 
creased  train  mileage  cost  which  it  occasions,  and  pays 
no  more  towards  terminal  costs  than  traffic  moving 
much  less  distances.  The  reason  is  that  the  longer 
distance  traffic  adds  no  more  to  total  terminal  expenses 
than  does  traffic  for  shorter  distances.  It  is  a  waste  of 
the  community’s  labor  and  is,  therefore,  socially  un¬ 
desirable,  that  traffic  should  be  taken  which  cannot 
pay  enough  to  meet  the  terminal  expenses  which  it 
occasions. 

Third,  we  have  to  consider  the  influence  on  rates,  of 
general  expenses.  These  expenses  do  not  vary,  in  any 
corresponding  degree,  as  traffic  varies,  but  they  will 
cease  if  a  road  is  content  to  do  no  business  whatever. 
As  a  consequence,  a  railroad  company  will  take  traffic 
which  does  not  pay  its  apparent  share  of  the  general 
expenses,  rather  than  not  to  get  this  traffic,  provided 
the  rate  which  can  be  charged  covers  the  cost  of  train 
mileage,  terminal  expenses,  and  something,  however 
little,  towards  the  general  expenses.  If  any  traffic  will 
yield  so  much,  a  railroad  is  better  off  with  it  than  with¬ 
out  it,  provided  the  road’s  equipment  and  plant  are  not 
too  congested  to  make  any  greater  traffic  worth  while. 
Since  the  general  expenses  have  to  be  met  before  any¬ 
thing  is  left  over  for  profit,  it  is  better  to  take  additional 
traffic,  as  long  as  the  plant  is  not  congested,  which  will 
aid  in  paying  these  expenses,  than  not  to  take  it,  utilize 
the  plant  less  fully,  and  get  less  profit.  But  it  should 
be  emphasized  that  if  the  total  traffic  of  a  railroad  does 
not  pay  the  necessary  general  expenses,  and  if  it  is  not 
expected  to  do  so  in  future,  business  will  stop  and  the 


THE  COST  OF  TRANSPORTATION 


i7 


road  be  abandoned ; 1  or  such  general  expenses  as  re¬ 
pairs  may  cease  temporarily  to  be  met,  and  the  road 
will  be  finally  abandoned  when  it  can  no  longer  be  used 
without  its  owners  meeting  these  expenses.2 

Social  economy  does  not  require  that  each  train  load 
of  freight  should  pay  just  as  much  towards  general 
expenses  as  every  other  train  load.  The  needs  of  the 
community  may  make  it  desirable  that  a  railroad  should 
connect  two  given  places,  A  and  B ,  and  hence  that  the 
general  expenses  of  maintaining  the  system  should  be 
met,  even  if  only  certain  kinds  of  traffic  can  be  secured 
to  carry  between  these  places.  Suppose,  however,  that 
there  is  other  traffic  which  the  plant  can  perfectly  well 
accommodate,  but  which  cannot  be  taken  if  the  charge 
for  its  carriage  covers  much  more  than  the  necessary 
train  mileage  and  terminal  expenses  incident  to  this 
carriage.  We  may  assume  that  this  traffic,  if  it  took 
place,  would  be  from  A  to  B ,  that  the  goods  carried 
could  be  produced  more  cheaply  at  A  than  at  B  to  the 
extent  of  a  saving  of  $10.05  worth  of  labor  and  material. 
Assume,  also,  that  the  cost  of  labor  and  material  (fuel, 
etc.)  incident  to  carrying  the  goods,  i.e.  the  train  mileage 
expenses  and  terminal  expenses,  is  $10.  Then  it  is 
desirable  that  the  goods  should  be  carried.  There  is  a 
saving  to  the  community  of  5  cents  from  carrying  them. 
This  is  not  much,  but  it  is  something.  Since  the  general 
expenses  are  no  greater  because  of  this  traffic,  the  labor 
and  materials  required  to  carry  it  yield  a  benefit  as 
great  as  or  slightly  greater  than  the  same  labor  and 

1  Cf.  Fisher,  Elementary  Principles  of  Economics,  New  York  (Macmillan), 
1912,  p.  328. 

2  Though  these  expenses  may  be  met,  temporarily,  for  the  sake  of  patronage, 
etc.,  if  there  is  hope  for  better  things  in  the  future.  Cf .  Hadley,  Railroad  T rans- 
portation,  New  York  (Putnam),  1885,  pp.  70,  71. 


PART  III  —  C 


18  TRANSPORTATION  COSTS  OF  COMMERCE 


materials  would  produce  if  otherwise  employed.  To 
carry  goods  which  pay  very  little  towards  general  ex¬ 
penses  is  not,  therefore,  necessarily  to  divert  labor  from 
a  more  productive  into  a  less  productive  employment; 
it  may  be,  if  the  railroad  plant  is  not  already  fully 
utilized,  the  reverse.1 

But  if  the  total  traffic  of  a  railroad  cannot  pay  enough 
to  cover  general  expenses,  then  it  is  economically  unde¬ 
sirable  that  the  road  should  operate  and  continue  to 
carry  goods.2  For  if  the  total  traffic  cannot  pay  the 
general  expenses,  as  well  as  train  mileage  and  terminal 
expenses,  then  presumably  it  is  not  worth,  to  the  com¬ 
munity,  the  equivalent  of  these  expenses.  In  other 
words,  the  transportation  service  yielded  by  the  railroad 
is  not  equal  in  value  to  the  services  or  the  wealth  which 
the  same  labor  (or  labor  and  materials,  e.g.  coal 3)  could 
produce  if  devoted  to  other  industries. 

Fourth  and  last  comes  a  consideration  of  fixed  charges 
or  sunk  costs,  and  of  the  influence  which  is  or  is  not 
exerted  by  them  upon  railroad  rates.  Fixed  charges, 
or  at  least  that  part  of  them  which  represents  interest 
on  a  railroad  company’s  debt,4  must  be  paid  whether 

1  If  a  portion  of  the  plant,  e.g.  a  track,  which  might  otherwise  be  abandoned, 
is  kept  up  in  order  that  any  special  part  of  the  total  possible  traffic  may  be 
taken,  in  order,  for  instance,  that  coal  may  be  carried  on  a  given  railroad  as  well 
as  wheat ;  then  the  additional  expense  of  upkeep  is  borne  for  the  sake  of  that 
special  part  of  the  traffic  and  ought  to  be  covered  by  the  rates  which  such  traffic 
pays.  But  in  practice  it  frequently  happens  that  a  given  plant,  e.g.  a  roadbed 
and  two  tracks,  is  in  any  case  required  for  a  proportion  only  of  the  possible 
business  between  two  given  places.  This  roadbed  and  these  tracks,  once  con¬ 
structed,  can  be  more  or  less  completely  utilized  without  corresponding  varia¬ 
tions  of  the  general  expenses,  and  without  the  possibility  of  allocating  these 
expenses  to  different  parts  of  the  business. 

2  Except  temporarily,  until  the  need  of  repairs,  etc.,  becomes  imperative. 

3  Involving,  of  course,  labor  for  its  production. 

4  Taxes  are  generally  placed  among  fixed  charges,  but  are  sometimes  levied 
on  gross  earnings  and  so  vary  with  business.  If  rentals  are  not  paid,  leased  lines 


THE  COST  OF  TRANSPORTATION 


19 

traffic  is  large  or  small.  Stopping  the  business  and 
abandoning  the  road  will  not  relieve  the  corporation  of 
its  interest  obligations,  so  long  as  it  is  not  bankrupt. 
It  may  better  run  at  a  loss  than  not  to  run  and  thereby 
suffer  greater  loss.1  Therefore,  a  road  may  continue  to 
carry  traffic,  even  although  the  goods  carried  do  not  pay 
enough  to  meet  all  the  fixed  charges. 

Even  if,  because  it  cannot  pay  full  interest  on  its 
debt,  a  railroad  company  becomes  bankrupt,  its  plant 
is  likely  still  to  be  operated.  The  bond  holders  would 
probably  continue  to  operate  the  system  after  fore¬ 
closure  had  given  them  control,  if  it  yielded  or  could  be 
expected  to  yield  much  beyond  general  expenses,  even 
though  the  per  cent,  profit  should  be  less  than  average 
interest  on  their  original  investment.  As  we  have  seen, 
fixed  charges  are,  in  large  part,  interest  on  a  funded 
debt,  i.e.  interest  on  that  part  of  the  sunk  cost  which 
was  met  by  bond  holders.  Taking  the  capital  as  a 
whole,  it  has  in  large  part  been  invested  once  for  all. 
A  great  part  of  the  investment  cannot  be  withdrawn 
for  other  purposes.  It  must  be  used  as  a  railroad  or 
abandoned.  So  far  as  this  is  true  of  a  railroad  plant 
and  equipment,  the  rate  for  transporting  any  given 
traffic  will  be  made  without  any  reference  to  fixed  charges 
or  to  sunk  costs.2  The  managers  of  the  road  will  en¬ 
deavor,  in  any  case,  to  get  for  the  road  all  the  profit  they 
can  get.  But  they  may  accept  a  rate  lower  than  a 
really  paying  rate  rather  than  not  get  traffic.  If  six  per 
cent,  cannot  be  earned,  it  is  nevertheless  better  to  earn 

must  be  surrendered.  But  there  is  nevertheless  the  sunk  cost  of  such  lines  to 
be  considered,  even  though  the  lines  become  independent. 

1  See  Hadley,  Railroad  Transportation,  pp.  70,  71. 

2  Assuming,  of  course,  that  the  rate  is  made  by  the  managers  intelligently 
and  without  government  compulsion. 


20  TRANSPORTATION  COSTS  OF  COMMERCE 


two  or  three  per  cent,  than  nothing.  Not  only,  there¬ 
fore,  may  certain  parts  of  a  railroad’s  business  pay  little 
or  nothing  towards  the  fixed  charges  or  towards  interest 
on  the  capital  investment,  but  even  the  traffic  as  a  whole 
may  be  accepted  at  rates  yielding  an  inadequate  return 
on  the  original  cost  of  the  plant  rather  than  that  traffic 
should  be  much  smaller  and  return  on  cost  still  less. 
The  fixed  charges,  or  sunk  costs,  also,  cannot  be  allo¬ 
cated  or  attributed  to  any  special  traffic.  Provided  the 
railroad  plant  is  not  fully  utilized,  traffic  which  can  con¬ 
tribute  but  little  above  the  incident  train  mileage  and 
terminal  costs  of  its  own  moving,  nevertheless  adds 
something  towards  general  expenses,  fixed  charges,  and 
profits,  and  is  worth  taking.1 

It  is  desirable  from  the  point  of  view  of  the  greatest 
total  of  national  wealth,  that  the  plant  should  be  used 
even  if  the  return  realizable  is  less  than  that  which 
could  have  been  realized  in  other  industries.  In  that 
case,  it  is  true  that  the  labor  of  constructing  the  rail¬ 
road  plant  has  been  devoted  to  a  less  profitable  instead 
of  a  more  profitable  industry.  But  this  labor  has  been 
expended  and  cannot  be  reclaimed.  If  the  results  of  its 
application  are  not  cast  aside,  i.e.  if  the  railroad  plant 

1  By  way  of  qualification  it  should  be  said  that  if  a  road  is  congested  and  can¬ 
not  carry  all  the  traffic  offered,  then  the  traffic  which  can  pay  least  is  the  traffic 
which  it  should  reject ;  and  additional  trackage  should  not  be  constructed  for 
this  traffic  unless  the  rates  chargeable  can  be  expected  to  yield  fair  returns  on 
the  cost  of  such  further  construction.  But  it  is  apt  to  be  the  case,  in  practice, 
that  the  trackage  which  is  in  any  case  required  for  a  considerable  amount  of  well¬ 
paying  traffic,  is  also  sufficient  for  the  accommodation  of  other  traffic  which  is, 
therefore,  worth  taking  even  at  somewhat  lower  rates.  Also,  if  additional 
trackage  is  mistakenly  constructed  for  traffic  which  proves  to  be  relatively 
unprofitable,  it  may  nevertheless  pay  better  to  take  this  traffic  at  low  rates 
than  to  refuse  it.  It  should  be  hardly  necessary  to  add  that  if  a  railroad  com¬ 
pany’s  trackage,  bridges,  stations,  etc.,  are  capable  of  doing  more  work  without 
additional  construction,  it  may  be  desirable  to  take  additional  traffic  at  low 
rates,  even  though  this  traffic  necessitates  some  increase  of  rolling  stock. 


THE  COST  OF  TRANSPORTATION 


21 


which  has  been  constructed  is  used,  the  labor  of  using 
it  may  produce  as  much  as  and  even  more  than  it  could 
produce  if  otherwise  directed.  It  may  produce  not 
only  its  own  proper  return  but  some  return,  however 
inadequate,  on  the  misdirected  labor  of  construction. 
The  labor  of  construction  plus  the  labor  of  utilization 
may  produce  a  less  value  return  than  if  it  had  been 
otherwise  directed ;  yet  since  the  labor  of  construction 
has  been  expended,  the  labor  of  utilization  may  add 
more  to  the  net  welfare  of  the  community  than  if  it 
were  turned  to  other  channels  and  the  railroad  plant 
abandoned. 

Cost  of  construction  of  plant  influences  railroad  rates 
in  so  far  as  this  cost  lies  in  the  future.  If  it  is  believed 
that  a  railroad  in  any  given  territory  and  connecting 
any  given  points  cannot  get  traffic  enough  or  charge 
high  enough  rates  to  earn  average  profit  or  interest  on 
the  investment,  capital  will  not  be  forthcoming  for  its 
construction.  If  a  railroad  already  built  cannot  get 
sufficient  traffic  or  charge  sufficiently  high  rates,  to  earn 
as  large  interest  returns  as  most  other  lines  of  business, 
competing  roads  are  less  likely  to  be  built ;  its  own  lines 
are  less  likely  to  be  extended;  the  supply  of  transpor¬ 
tation  is  thus  kept  down;  and  transportation  rates 
tend  to  be  kept  from  falling  further.  Even  expendi¬ 
tures  for  repairs  which  are  made  for  the  sake  of  traffic 
during  a  period  of  several  years  to  come  and  which  are, 
therefore,  of  the  nature  of  permanent  investment,  will 
not  be  made  if  it  is  believed  that  interest  on  these  expend¬ 
itures  will  never  be  realized.  It  is  desirable  from  the 
viewpoint  of  national  wealth  that  this  should  be  the 
case,  that  further  direction  of  labor  into  a  relatively 
unprofitable  line  should  be  prevented.  We  may  say, 


22  TRANSPORTATION  COSTS  OF  COMMERCE 


then,  that  over  a  period  of  many  years,  rates  must,  in 
general,  yield  a  fair  return  on  cost.1  In  a  business  re¬ 
quiring  such  tremendous  capital  investment,  the  oscil¬ 
lations  to  one  side  and  the  other  of  a  normal  return  may 
extend,  each,  over  a  considerable  period  of  time. 

Even  after  the  investment  has  been  made,  a  railroad 
will  not  continue  to  operate  indefinitely  if  it  is  believed 
that  no  return  whatever  can  be  realized.  For  part  of 
the  plant  can,  if  necessary,  be  used  in  alternative  ways. 
The  roadbed  may  have  been  rendered  useless  for  any 
other  purpose.  But  the  terminals,  and  especially,  per¬ 
haps,  the  land  on  which  the  terminal  structures  have 
been  placed,  would  have  value  and  would  yield  a  return, 
if  otherwise  used.  Though  a  railroad  unfortunately 
located  may,  therefore,  be  operated  for  what  would 
otherwise  be  an  inadequate  profit,  it  will  not  intention¬ 
ally  be  permanently  operated  for  a  less  profit  than  parts 
of  its  plant,  such  as  terminal  real  estate,  would  yield  in 
other  uses.2  Obviously,  it  is  not  desirable  that  the  rail¬ 
road  should  be  operated,  if  its  services  are  of  so  little 
value  to  the  public,  and  if  the  terminal  real  estate  and 
other  parts  of  the  plant  would  yield  greater  service  in 
other  uses. 


1  At  least,  investors  must  expect  this  if  their  capital  is  to  be  risked.  See 
discussion  in  Marshall,  Principles  of  Economics,  6th  ed.,  London  (Macmillan), 
1910,  pp.  372-375  and  420,  421. 

2  If  it  is  objected  that  the  value  of  terminal  real  estate  for  any  use  depends 
largely  on  the  presence  of  the  railroad,  the  answer  may  be  made  that  this  is  not 
true  if  we  suppose  the  railroad  plant  to  be  decreased  by  small  increments  or  if 
we  suppose  the  places  in  question  to  be  served  by  several  railroads.  In  other 
words,  it  is  not  true  for  the  marginal  railroad  or  the  marginal  track  or  the  mar¬ 
ginal  construction  of  transportation  plant  in  general.  Furthermore,  while  it  is  a 
fact  that  the  presence  of  railroads  operates  to  increase  land  values,  it  is  also 
true  that  the  presence  of  other  industries  and  of  large  population  is  a  necessary 
condition  to  high  land  values  and,  therefore,  to  high  value  of  railroad-owned 
real  estate. 


THE  COST  OF  TRANSPORTATION 


2  3 


It  is  not  enough  to  say  that  a  railroad  should  not 
be  constructed  unless  it  will  yield  an  average  profit  on 
its  labor  cost.  It  should  yield,  also,  a  surplus  above 
this  amount,  as  great  as  the  land  space  required  would 
yield  in  the  best  alternative  use.  If  the  railroad  can¬ 
not  yield  such  a  return,  it  is  more  economical  to  use  the 
land  otherwise ;  the  transportation  use  is  not  as  impor¬ 
tant  as  the  other  use;  the  unwillingness  of  the  com¬ 
munity  to  pay  as  much,  in  transportation  rates,  for  this 
use,  as  they  can  be  induced  to  pay  for  the  other,  is  evi¬ 
dence  that  the  other  is  more  needed  or,  at  least,  more 
desired. 

The  growth  of  a  community  frequently  adds  greatly  to 
the  profits  of  railroads  and  other  land  owners.  The  land 
comes  to  have  more  rental  value  for  nearly  all  purposes. 
Though  this  community  growth  is  partly  due  to  rail¬ 
roads,  it  is  usually  the  result  of  many  causes  of  which 
the  building  of  any  particular  railroad  is  only  one.  It 
is  frequently  asserted,  therefore,  that  this  greater  profit 
of  railroads  is  unearned  and  that  it  should  not  be  en¬ 
joyed  by  the  owners  of  railroad  securities.  Assuming 
this  view  to  be  correct  (and  it  is  unnecessary  for  our 
present  purposes  to  prove  or  disprove  it),  the  conclusion 
does  not  follow  that  rates  should  be  reduced.  As  above 
stated,  a  railroad  does  not  justify  itself  unless  it  can 
earn  as  much  as  the  land  could  earn  in  some  other  use. 
If  the  rental  value  has  gone  up  for  other  uses  because 
of  community  growth,  presumably  the  amount  which 
the  land  can  earn  if  used  for  a  railroad,  will  be  greater. 
Rates  will  probably  not  be  higher  and  may  even  be 
lower,  but  business  will  be  larger.  To  reduce  rates  ar¬ 
bitrarily  by  law,  in  order  to  deprive  railroads  of  an 
alleged  unearned  increment,  would  serve  no  good  pur- 


24  TRANSPORTATION  COSTS  OF  COMMERCE 


pose.  It  would  be  a  discrimination  against  railroads 
as  compared  to  other  land  owners.  It  would  largely 
prevent  the  use  of  land  for  railroad  building,  even,  per¬ 
haps,  when  railroads  are  much  needed.  It  would  give 
the  benefit  of  the  unearned  increment  to  those  who 
patronize  the  roads  instead  of  to  those  who  own  them, 
or  to  the  different  members  of  the  community  in  pro¬ 
portion  to  the  use  each  makes  of  the  railroads.  It  would 
not  give  the  unearned  increment  to  the  public  as  a  whole, 
to  be  used  for  public  benefit.  If  the  unearned  increment 
belongs  to  the  whole  community,  as  is  frequently  claimed, 
this  community  right  can  be  asserted  with  least  incon¬ 
sistency  and  least  interference  with  an  economical  dis¬ 
tribution  of  labor  to  different  lines,  by  a  general  and 
properly  apportioned  tax  on  land  values. 

§  4 

Average  Railroad  Rates  as  Affected  by  Degree  of  Utiliza¬ 
tion  of  Railroad  Capital 

Since  expenses  for  the  production  of  train  mileage  do 
not  increase  in  proportion  to  traffic,  and  since  general 
expenses  and  fixed  charges  (or  sunk  costs)  taken  together 
do  not  greatly  depend,  within  the  limits  of  utilization 
of  plant,  upon  the  amount  of  traffic,  it  follows  that 
average  rates  can  be  made  lower  without  being  made  un¬ 
profitable,  if  utilization  of  plant  is  relatively  complete. 
Where  traffic  is  extremely  heavy,  even  though  there  are 
a  number  of  railroads  to  carry  it,  each  railroad  may  be 
fairly  well  utilized  and  so  able  to  make  low  rates.  Where 
traffic  is  very  light,  even  a  single  one-track  railroad  may 
be  utilized  to  so  slight  a  degree  that  its  rates  must  be 
high  to  yield  a  reasonable  profit. 


THE  COST  OF  TRANSPORTATION 


25 


We  have  said  that  the  tendency  to  decreasing  propor¬ 
tionate  cost  does  not  apply  to  the  same  extent  after 
existing  plant  is  fully  utilized,  though  it  may  apply  to 
some  extent  if  a  larger  plant  can  give  more  economical 
service  than  a  smaller.  A  double- track  road,  fully 
utilized,  may,  as  has  been  already  pointed  out,1  be  able 
to  carry  goods  more  cheaply  than  a  one-track  road. 
Trains  can  follow  each  other  more  closely  and  with  less 
switching,  each  track  being  used  only  for  the  traffic  in 
one  direction.  Maintenance  costs  will  not  probably  in¬ 
crease  in  proportion  to  the  efficiency  of  the  plant.  Simi¬ 
larly,  large  and  powerful  engines,  and  cars  of  great 
carrying  capacity,  which  it  would  not  pay  to  use  if 
traffic  were  small  and  the  average  train  load  light,  may 
mean  much  cheaper  transportation  if  the  volume  of 
traffic  justifies  their  use. 


Expenses  and  Rates  of  Water  Transportation 

Expenses  of  water  transportation  may  be  classified 
in  much  the  same  way  as  expenses  of  rail  transportation. 
First,  there  are  the  expenses  which  pertain  particularly 
to  moving  the  traffic,  and  depend  most  nearly  upon  the 
amount  of  traffic.  This  class  of  expenses  includes  fuel, 
wear  and  strain  on  machinery  and  vessels,  so  far  as  due 
to  use,  and,  in  a  great  degree,  wages  of  seamen.  Even 
these  expenses  do  not  vary  strictly  in  proportion  to 
traffic,  since  they  are  not  twice  as  great  for  a  vessel  fully 
loaded  as  for  one  carrying  only  half  a  cargo.  But  in 
the  case  of  the  tramp  vessel,  sailing  almost  invariably 
only  after  it  has  secured  a  full  or  nearly  full  cargo,  these 

1  §  2  of  this  Chapter  (I  of  Part  III). 


26  TRANSPORTATION  COSTS  OF  COMMERCE 


expenses  probably  vary  in  something  like  the  same 
proportion  as  business.  And  traffic  which  cannot  pay 
enough  to  cover  these  expenses  would  be  refused. 

Second,  we  have  terminal  expenses,  including  the  cost 
of  loading,  unloading,  and  transshipping,  the  charges 
for  pilotage  and  towage,  charges  for  wharf  space,  etc. 
If  a  navigation  company  owns  the  wharves  it  uses,  part 
of  the  expense  for  wharf  repairs  may  properly  be  classed 
with  terminal  costs.  Terminal  expenses  vary  to  a  con¬ 
siderable  degree  as  the  volume  of  traffic  but  not  in 
proportion  to  the  distance  it  is  carried.  All  traffic 
carried  must  therefore  pay  enough  to  cover  the  incident 
terminal  costs,  but  traffic  carried  long  distances  will  not 
necessarily  be  required  to  pay  higher  rates  than  that 
carried  short  distances,  except  as  the  mere  cost  of  carry¬ 
ing  it  is  greater. 

General  expenses,  in  the  case  of  navigation  companies, 
include  some  of  the  expenses  of  managing,  e.g.  the  salaries 
of  ship  officers  so  far  as  these  salaries  may  be  steady 
regardless  of  increases  or  decreases  of  traffic.  In  the 
case  of  companies  operating  a  line  of  ships,  expenses  for 
general  oversight,  freight  soliciting,  etc.,  would  have  to 
be  included.  General  expenses  would  include,  also, 
cleaning  of  the  hulls  of  vessels,  part  of  the  repairs,  part 
of  the  expense  of  wharf  maintenance  where  a  company 
itself  owns  the  wharves  used,  etc.  These  expenses 
would  stop  if  business  were  given  up  and,  therefore,  the 
business  as  a  whole  must  cover  them ;  but  they  do  not 
vary  as  traffic  varies,  cannot  be  definitely  allocated,  and 
do  not  fix  a  minimum  rate  for  any  particular  business. 
If  it  is  necessary  to  get  the  business,  a  rate  may  be  made 
for  certain  special  traffic,1  or  between  certain  special 

1  See,  however,  §  6  of  this  Chapter  (I  of  Part  III). 


THE  COST  OF  TRANSPORTATION 


27 


points,1  or  during  a  given  period  of  time  or  season  when 
business  is  not  easy  to  secure,  which  pays  but  little 
towards  the  general  expenses.  It  is  better  to  take 
traffic  which  helps  to  pay  the  general  expenses,  even  if 
it  does  not  pay  what  appears  to  be  its  mathematically 
proportionate  share,  than  to  refuse  this  traffic  and  so 
lose  the  smaller  share  which  it  can  pay.  Only  if  equip¬ 
ment  is  fully  utilized  by  the  better  paying  traffic,  can 
traffic  which  contributes  even  but  a  little  towards  general 
expenses  be  properly  refused.  On  the  other  hand, 
traffic  as  a  whole  must  pay  enough,  in  the  long  run,  to 
cover  general  expenses,  or  it  will  not  be  worth  while  for 
a  navigation  company  to  continue  operating. 

Fixed  charges  include  interest  on  the  original  cost  of 
ships  and  of  terminals,  if  construction  is  with  borrowed 
capital.  In  any  case,  the  original  cost  is  a  sunk  cost. 
It  cannot  be  recovered  (except  so  far  as  the  materials 
used  have  value  as  lumber  or  old  iron,  etc.)  if  the  invest¬ 
ment  of  capital  proves  to  have  been  unwise.  The  indi¬ 
vidual  investor  may  sometimes  recover  it  by  disposing 
of  his  ships  to  some  one  else  for  more  than  they  are 
worth,  but  for  society  as  a  whole,  the  choice  cannot  be 
made  again.  The  fixed  charges  or  sunk  costs  do  not 
vary  with  traffic  and  cannot  be  definitely  allocated. 
They  do  not  fix  a  minimum  rate  for  any  special  traffic. 
Part  of  the  cargo  of  a  regular-line  ship  (which  must  sail 
on  schedule,  whether  loaded  or  not)  may  pay  but  little 
towards  the  fixed  charges  or  even  towards  general  ex¬ 
penses,  and  yet  be  worth  taking  if  traffic  is  light  and  noth¬ 
ing  else  can  be  had  to  make  up  a  full  cargo.2  Even  a 
vessel  carrying  cargoes  in  bulk,  e.g.  a  “  tramp  ”  vessel, 

1  See  remarks  at  end  of  §  1  in  Chapter  IV  (of  Part  III) . 

*  Except  roughly  over  extremely  long  periods.  See  remainder  of  this  section. 


28  TRANSPORTATION  COSTS  OF  COMMERCE 


may  sometimes  carry  freight  during  a  dull  season  or  on 
a  single  trip,  though  this  traffic  does  not  pay  the  usual 
profit,  rather  than  to  refuse  the  traffic  and  get  no 
profit. 

If  the  business  as  a  whole  of  a  navigation  company 
does  not  pay  general  expenses  and  cannot  be  expected 
to,  abandonment  of  ships  is  more  economical  than  con¬ 
tinued  use,  although  in  some  cases  vessels  can,  as  rail¬ 
roads  cannot,  be  taken  into  other  districts  where  their 
use  might  pay.  But  if  the  traffic  pays  all  the  general 
expenses  and  something  besides,  even  if  this  surplus  is 
not  a  fair  interest  on  the  original  investment  (but  is  fair 
interest  on  the  value  of  the  material  for  other  uses), 
continued  operation  is  worth  while.  If  ships  have  been 
mistakenly  built  for  traffic  which  cannot  bear  profitable 
rates,  or  if  they  have  been  built  too  small  or  too  large 
for  the  most  efficient  service,  it  is  nevertheless  better  to 
earn  2  or  2\  per  cent,  than  nothing.  It  is  better  from 
the  viewpoint  of  national  wealth  that  such  equipment 
should  be  used  even  if  its  construction  has  involved  a 
partial  waste  of  labor,  than  that  the  equipment  should 
not  be  used  and  that  the  labor  of  its  construction  should 
be,  therefore,  a  total  waste. 

If,  however,  the  average  rate  chargeable,  multiplied 
by  the  traffic,  cannot  yield  enough  to  pay  fair  interest 
on  investment  in  ships,  new  ships  are  not  likely  to  be 
built  as  rapidly  as  commerce  increases,  or  even,  perhaps, 
fast  enough  to  replace  the  old  as  they  become  unsea¬ 
worthy.  As  long  as  existing  ships  can  be  kept  in  service 
by  not  too  extensive  repairing,  they  will  be  used.  But 
anything  in  the  nature  of  renewed  investment  will  not 
occur.  It  would  involve  a  diverting  of  labor  into  a 
relatively  unprofitable  line,  if  it  did  occur.  So,  in  the 


THE  COST  OF  TRANSPORTATION 


29 


long  run,  although  not  necessarily  over  a  period  even  of 
several  years,  rates  charged  must  cover  interest  on 
investment,  else  supply  of  service  will  not  equal  de¬ 
mand. 

§  6 

Comparative  Importance  of  General  Expenses  and  Fixed 

Charges  on  Railroads ,  on  Natural  Waterways ,  and  on 

Canals 

It  should  be  particularly  emphasized  that  transpor¬ 
tation  on  the  ocean  and  sometimes  on  lakes  and  rivers 
differs  from  railway  transportation  in  the  relative  un¬ 
importance  of  general  and  fixed  charges.  There  are  no 
appreciable  general  expenses  in  ocean  navigation  for 
maintenance  of  way,1  and  there  are  no  fixed  charges  (or 
sunk  costs)  resulting  from  the  necessity  of  constructing 
a  way  or  roadbed  and  tracks  for  the  passage  of  cars. 
Both  general  expenses  and  fixed  charges  appear  to  be 
of  less  relative  importance  in  the  case  of  ocean  and 
sometimes  lake  and  river  transportation.  Water  trans¬ 
portation  seems,  therefore,  not  to  be  so  markedly  a 
business  of  decreasing  proportionate  expense  or  increas¬ 
ing  return.2 

Furthermore,  in  the  case  of  securing  rail  transportation 
between  two  distant  points,  the  least  possible  invest¬ 
ment  is  a  roadbed  and  a  single  track,  costing,  perhaps, 
millions  of  dollars ;  though  the  traffic  available  may  not 
at  all  fully  utilize  such  a  plant.  It  is  very  apt  to  be  the 
case,  therefore,  that  if  there  is  enough  of  paying  traffic 

1  Except  as  lighthouse  service,  etc.,  may  be  so  regarded ;  and  this  is  an  ex¬ 
pense  usually  borne  by  government. 

2  Cf.  Report  of  the  Commissioner  of  Corporations  on  Transportation  by 
Water  in  the  United  States,  1909,  Part  I,  pp.  13,  14. 


3o  TRANSPORTATION  COSTS  OF  COMMERCE 


to  warrant  building  the  road,  it  will  be  worth  while  to 
take  additional  traffic  at  lower  rates,  when  such  addi¬ 
tional  traffic  will  pay  anything  whatever,  however  little, 
towards  net  profits.  In  the  case  of  transportation  on  a 
natural  waterway,  however,  nothing  but  vessels  and 
wharves  have  to  be  constructed.  If  possible  traffic  is 
small,  fewer  vessels  will  need  to  be  constructed  for  it,  or 
the  vessels  constructed  may  be  made  of  smaller  size.  In 
a  sense,  a  part  of  a  vessel  can  be  constructed  for  the 
traffic,  since  a  vessel  to  be  used  mainly  for  other  traffic 
can  make  an  occasional  trip  between  the  two  points 
in  question.  Thus,  in  the  case  of  transportation  on 
natural  waterways,  excess  facilities  on  which  to  pay 
interest  are,  perhaps,  less  frequently  constructed,  and 
there  is  probably  less  occasion  to  seek  additional  traffic 
at  lower  than  average  rates,  in  order  to  utilize  such 
facilities.  So  far,  of  course,  as  larger  vessels  are  a  dis¬ 
tinctly  more  economical  means  of  carrying  freight  than 
smaller  ones,  there  is  a  motive  for  building  ships  large, 
even  if,  fully  to  utilize  them,  some  freight  must  be  taken 
at  slightly  less  than  average  rates. 

Water  transportation  expenses  seem  to  be  more 
analogous  to  railroad  expenses,  when  vessels  navigate  a 
canal  or  other  waterway  on  the  improvement  of  which 
much  money  has  been  spent.  The  annual  cost  of 
maintaining  the  canal  or  other  waterway,  e.g.  dredging 
or  repairing,  or  both,  may  be  regarded  as  very  largely  a 
general  expense.  The  amount  spent  in  constructing  or 
improving  the  waterway  is  a  sunk  cost,  and,  if  the 
money  was  borrowed,  interest  on  it  should  be  regarded 
as  a  fixed  charge.  As  a  matter  of  practice,  such  improve¬ 
ments  are  commonly  made,  in  this  country,  by  govern¬ 
ment,  and  the  interest  is  apt  to  be  regarded,  not  as  a 


THE  COST  OF  TRANSPORTATION 


3i 


fixed  charge  on  the  traffic,  which  ought  to  bear  it,  but  as 
a  fixed  charge  on  tax-payers. 

Taking  the  case  of  a  canal,  the  logical  conclusion, 
according  to  the  principles  which  have  been  set  forth 
in  this  chapter,  regarding  railroads,  is,  that  no  goods 
should  pass  through  without  paying  whatever  extra 
costs  their  carrying  occasions,  including  cost  of  moving, 
wear  occasioned  on  the  canal,  etc. ;  that  traffic  which 
can  pay  that,  and  anything  besides  towards  general 
expenses,  should  be  accepted  rather  than  rejected,  if 
plant  is  not  fully  utilized;  that  the  traffic  as  a  whole 
must  pay  all  general  expenses  of  operating  the  canal  and 
keeping  it  in  repair,  else  permanent  operation  will  not 
pay ;  that  it  may  be  better  to  operate  for  a  small  profit, 
once  the  canal  has  been  constructed,  than  to  refuse  to 
operate  because  profits  are  not  large;  that  the  con¬ 
struction  of  a  canal  or  the  improvement  of  any  water¬ 
way  should  not  be  undertaken  unless  a  profit  approxi¬ 
mating  that  in  other  investments  is  reasonably  to  be 
expected,  and  that  the  construction  or  improvement  of 
a  waterway  when  such  returns  cannot  be  had,  involves 
a  diversion  of  labor  from  a  more  profitable  into  a  less 
profitable  line.  It  may  be  added  that  a  canal,  like  a 
railroad,  should  not  be  constructed  if  some  other  use  of 
the  necessary  land  space  would  yield  a  larger  return. 

§  7 

The  Proper  Basis  of  Wharf  Charges 

Wharves  are  often  owned  by  other  interests  than  those 
owning  the  vessels  using  the  wharves,  not  infrequently 
by  states  or  municipalities.  It  may  be  worth  while, 
therefore,  to  give  brief  separate  attention  to  the  sub- 


32  TRANSPORTATION  COSTS  OF  COMMERCE 

ject  of  wharf  charges.  The  charges  for  use  of  a  wharf 
may  properly  be  high  enough,  taken  as  a  whole,  to  pay 
the  average  return  on  necessary  investment  for  construc¬ 
tion.  Also,  the  space  required,  if  it  has  value  for  other 
purposes  than  as  wharf  space  alone,  e.g.  for  the  loca¬ 
tion  of  a  manufacturing  plant  on  the  water’s  edge,  may 
rightly  be  made  to  yield  as  much  when  it  is  used  only 
as  a  wharf.  Otherwise,  the  space  is  devoted  to  one  use, 
and  some  other  use,  able  to  pay  more  and,  therefore, 
presumably  more  worth  while  to  the  community,  is 
excluded. 

Or  again,  if,  about  any  given  harbor,  the  space  which 
can  satisfactorily  be  utilized  for  wharves  is  limited,  the 
charge  for  use  of  wharves  may,  not  unjustifiably,  be 
high  enough  to  keep  the  demand  for  wharf  space  down 
to  the  available  supply,  or  to  keep  the  demand  for  the 
more  desirable  wharf  space  down  to  the  available  supply. 
Such  a  charge  cannot  operate  to  decrease  commerce, 
for  it  allows  all  the  commerce  for  which  there  are  facili¬ 
ties,  and  no  more  commerce  could  pass  through  a  given 
port  if  there  were  no  charge  whatever.  Neither  will 
such  a  charge  operate  to  raise  prices  to  consumers,  for 
it  will  not  limit  the  supply  of  goods  going  through  the 
given  port  or  over  the  desirably  located  wharves,  any 
more  than  such  supply  would  be  limited  anyhow  by  the 
lack  of  space.  The  limitation  of  the  supply  of  goods  is 
all  that  can  raise  their  prices,  and  the  supply  of  goods 
is  not  affected.  In  any  case,  the  remainder  of  the  goods, 
beyond  what  the  given  port  or  the  given  desirable 
wharves  could  provide  accommodation  for,  would  have 
to  go  inland  by  way  of  other  ports  or  other  wharves, 
and  the  competition  of  these  will  determine  supplies  and 
prices.  If  the  superior  port  or  wharves  did  not  charge 


THE  COST  OF  TRANSPORTATION 


33 


for  its  or  their  superiority,  the  fortunate  users  (ship  owners 
or  sellers  of  goods)  would  simply  get  a  surplus  profit 
over  what  their  rivals  could  get,  analogous  to  land  rent. 

The  proper  charge,  then,  is  a  fair  rent  for  the  space 
used,  based  upon  its  desirability  and  its  scarcity,  and  a 
fair  interest  for  any  necessary  cost  of  construction. 
This  is  what  the  charge  would  tend  to  be  under  com¬ 
petitive  conditions.  No  one  would  be  likely  to  charge 
more  for  his  wharf  space,  else  it  would  not  be  used.  No 
one  would  be  likely  to  charge  less,  for  the  demand  would 
make  it  possible  for  him  to  get  that  amount 1  whether 
others  chose  to  do  so  or  not.  What  would  be  a  normal 
competitive  charge  under  conditions  of  private  owner¬ 
ship  is  what  ought  to  be  charged  by  state  or  municipality 
if  it  owns  the  wharves. 

The  statement  that  a  proper  charge  includes  economic 
rent  for  space  required  does  not  necessarily  mean  that 
this  rent  should  go  ultimately  into  the  pockets  of  private 
persons.  Space  afforded  is  not  service  rendered  or  effort 
sustained  by  an  individual.  The  rent  for  it  may  plausi¬ 
bly  be  regarded  as  an  unearned  income  and  as  properly 
belonging  to  the  community.  But,  in  any  case,  the  rent 
of  wharf  area  constitutes  in  this  regard  no  separate 
problem.  It  should  be  judged  along  with  the  problem 
of  land  rent  in  general. 

§  8 


Economic  Objections  to  Monopolistic  Transportation 

Rates 


Up  to  this  point  we  have  been  concerned  chiefly  with 
the  question  of  what  expenses  transportation  rates  ought 

1  See  Part  I,  Chapter  I,  §  2. 


PART  III  —  D 


34 


TRANSPORTATION  COSTS  OF  COMMERCE 


to  cover  and  what  returns  on  investment  they  ought  to 
yield.  A  few  words  should  be  added  regarding  what 
returns  they  ought  not  to  yield.  They  ought  not  to 
yield  monopoly  profits.  High  rates  yielding  surplus  or 
monopoly  profits  are  distinctly  adverse  to  the  general 
interest.  Not  only  do  they  involve  an  unfortunate  dis¬ 
tribution  of  the  products  of  industry,  but  also  they  in¬ 
volve  a  diminution  in  the  total  amount  of  these  products. 
For  a  monopolistic  transportation  company  will  charge 
those  rates  on  each  kind  of  traffic  which  yield  the  largest 
profit,  even  though  a  lower  average  of  rates  would  be 
profitable,  would  more  fully  utilize  the  transportation 
plant,  and  would  widen  the  field  of  commerce.  Monop¬ 
oly  rates  prevent  transportation  which  would  be  worth 
to  the  community  the  labor  cost  required,  which  would 
be  worth  fair  rates,  but  which  cannot  take  place  when 
excessive  rates  are  charged.1  Monopoly  rates,  like 
tariffs,  interfere  with  commerce  between  communities, 
with  commerce  which  would  be  profitable,  if  not  thus 
prevented,  to  both  or  all  the  communities  engaged  in  it. 

§  9 

Summary 

The  discussion  of  expenses  of  water  transportation  has 
already  given  us,  because  of  the  analogy  between  the 
two,  something  of  a  review  of  the  principles  regarding 
railroad  expenses.  A  brief  summary  of  the  conclusions 
of  this  chapter  may,  therefore,  suffice.  For  both  rail 
and  water  transportation,  we  made  a  fourfold  classifi- 

1  It  is  impossible  for  the  monopolistic  company  to  avoid  this  result  by  making 
low  rates  on  such  particular  parts  of  its  traffic  only  as  are  for  the  use  of  hesitating 
consumers,  since  nobody  knows  who  these  consumers  are  or  which  special  tons 
Or  bushels  will  eventually  go  to  them. 


THE  COST  OF  TRANSPORTATION 


35 

cation  of  expenses.  First  there  are  the  expenses  per¬ 
taining  most  particularly  to  the  moving  of  goods. 
Second  there  are  terminal  expenses,  affected  by  the 
volume  of  traffic  but  not  by  the  distance  carried.  Third, 
there  are  general  expenses  which  will  cease  if  the  plant 
or  capital  equipment  is  abandoned  but  which  change 
only  a  little  with  considerable  increases  or  decreases  of 
business.  Fourth,  there  are  fixed  charges  or  sunk  costs, 
which,  once  the  investment  has  been  made,  do  not  vary 
with  traffic.  Each  item  of  traffic  must  pay  a  rate  high 
enough  to  cover  the  additional  expenditure  which  it 
occasions.  To  carry  traffic  which  cannot  pay  this  in¬ 
volves  economic  waste.  Traffic  as  a  whole  must  cover 
general  expenses,  else  continuance  of  transportation 
service  becomes  unprofitable.  Construction  of  trans¬ 
portation  facilities  should  not  be  undertaken  unless  there 
is  reasonable  probability  that  traffic  as  a  whole  can  pay 
a  fair  return  on  investment.  Yet  if  investment  has  been 
mistakenly  made,  it  may  be  better  to  operate  for  small 
return  than  to  abandon  the  capital  so  invested.  Total 
charges  should  be  high  enough  to  pay  at  least  as  large 
returns  beyond  interest  on  construction  cost  as  the 
space  used  would  yield  if  devoted  to  the  best  alternative 
purpose.  Up  to  the  limit  of  complete  utilization  of 
plant,  expenses  of  transportation  increase  less  rapidly 
than  business.  Beyond  that  limit,  they  may  increase 
less  rapidly  than  business  if  the  larger  plant  is  more 
efficient  than  the  smaller.  But  additions  to  plant  may 
mean,  for  a  time,  incomplete  utilization  and  so  greater 
proportionate  expense.  Water  transportation  on  free 
waterways  appears  to  be  less  subject  to  the  tendency 
towards  decreasing  proportionate  expense  than  rail 
transportation,  because  there  are  no  corresponding 


36  TRANSPORTATION  COSTS  OF  COMMERCE 


expenses  for  construction  and  maintenance  of  way. 
Water  transportation  on  canals  is  in  this  regard  more 
analogous  to  rail  transportation.  Wharf  charges  should 
cover  interest  on  necessary  construction  cost  plus  a 
normal  land  rent  for  the  space  used.  Finally,  as  to  both 
rail  and  water  transportation,  the  conclusion  is  that 
monopoly  rates  are  uneconomical  as  well  as  unfair,  since 
they  tend,  like  tariff  restrictions,  to  interfere  with  com¬ 
merce  which  is  normally  profitable  and  which  ought  to 
be  allowed  to  take  place. 


CHAPTER  II 


The  Competition  of  Transportation  Companies 


Competition  of  Routes 

Competition  of  transportation  lines  may  be  classified 
as  of  four  kinds:  competition  of  different  companies 
over  the  same  route,  competition  of  routes,  competition 
of  directions,  and  competition  of  locations.  Let  us 
consider  these  four  kinds  of  competition  in  order.  Com¬ 
petition  of  different  lines  over  the  same  route  applies 
particularly  to  transportation  on  free  waterways,  for 
example,  on  the  ocean.  In  such  transportation,  the  way 
or  route  is  not  the  possession  of  any  one  company  but 
may  be  used  by  all.  The  different  companies  operating 
over  a  given  route  may  be  in  competition  with  each  other. 

Competition  of  routes  may  exist  between  navigation 
companies  or  railroad  companies  or  both.  By  com¬ 
petition  of  routes  is  meant  competition  between  two 
or  more  different  routes  or  lines  of  transportation,  either 
or  any  of  which  can  carry  goods  between  two  given 
points.  Such  a  competition,  for  example,  is  that  which 
obtains  between  Chicago  and  New  York.  These  cities 
are  joined  by  a  number  of  transportation  lines.  Goods 
moving  between  these  two  points  have  a  choice  of 
routes;  and  the  tendency  is  for  the  goods  to  be  sent, 
in  each  case,  by  that  route  which  is,  for  the  shipper, 
most  economical,  considering  rates,  speed,  liability  to 

37 


38  TRANSPORTATION  COSTS  OF  COMMERCE 


injury,  etc.  Some  of  the  possible  routes  are :  that  by 
the  Great  Lakes,  the  St.  Lawrence  River,  and  the  Atlan¬ 
tic  Ocean,  that  by  the  Lake  Shore  and  Michigan  South¬ 
ern  and  the  New  York  Central  railways,  that  by  the 
Pennsylvania  lines,  and  others.  The  transportation  of 
wheat,  corn,  and  other  farm  products  from  American 
centers  of  production  to  Europe,  e.g.  between  Chicago, 
St.  Louis,  etc.,  in  the  United  States,  and  Liverpool  in 
England,  is  another  example.  These  products  can 
frequently  be  taken  via  the  Great  Lakes,  via  any  of 
the  trunk  lines,  or  via  lines  operating  in  southern  terri¬ 
tory  to  Norfolk,  Galveston,  or  New  Orleans,  and  thence 
to  Liverpool.  Still  another  example  of  competition  of 
routes  is  the  traffic  from  Australia  and  China  to  New 
York,  which  may  be  carried  either  by  ship  westward 
via  the  Suez  Canal  or  by  ship  eastward  to  San  Francisco 
and  thence  by  rail  to  New  York  (soon  also,  doubtless, 
the  Panama  Canal  will  be  a  permanently  available 
avenue  of  transport).  These  two  different  routes  are 
in  vigorous  competition  for  the  traffic.1  We  have 
substantially  the  same  kind  of  competition,  i.e.  of 
routes,  when  goods  are  stored  with  wholesalers  or 
jobbers  at  intermediate  points,  and,  likewise,  when 
they  are  changed  in  form,  say  from  raw  materials  to 
finished  products,  at  intermediate  points,  provided 
source  and  destination  of  traffic  by  the  various  routes 
are  about  the  same.  The  different  transportation  com¬ 
panies  compete,  each  to  carry  goods  from  the  common 
source  to  manufacturers  or  jobbers  on  its  own  line 
and  thence  to  the  common  market.  Each  trans¬ 
portation  company  desires  that  the  conditions  shall 
be  as  favorable  for  such  stoppage  and  reshipment  on 

1  McPherson,  Railroad  Freight  Rates,  New  York  (Holt),  1909,  p.  146. 


COMPETITION  OF  COMPANIES 


39 


its  line  as  on  rival  lines.  In  order,  however,  that  the 
competition  of  routes  between  two  or  more  rail  or 
water  lines  may  be  availed  of,  it  is  not  necessary  that 
the  goods  to  be  shipped  should  be  produced  at  a  point 
where  several  such  lines  meet.  It  is  only  necessary 
that  the  goods  should  be  produced  within  reasonable 
wagon-  or  truck-hauling  distance  from  such  routes. 
Thus,  within  the  wheat-  and  corn-producing  regions  of 
the  United  States,  numbers  of  farms  are  located  near 
enough  to  two  or  more  railroad  lines  to  exercise  a  real 
choice  among  these  lines. 

Competition  of  routes  may  mean  and  frequently 
does  mean  that  goods  are  taken  to  their  destination 
by  a  very  roundabout  way.  Sometimes  the  distance 
freight  is  actually  carried  in  being  taken  from  one  point 
to  another  is  from  50  to  100  per  cent,  greater  than  the 
shortest  possible  distance.1  In  the  Savannah  fertilizer 
case,  for  example,  it  was  shown  that  goods  were  carried 
from  Charleston,  S.C.,  to  Valdosta,  Ga.,  by  connecting 
lines  of  railroad,  a  distance  of  413  miles,  when  they  might 
have  been  carried  by  a  more  direct  line  to  Valdosta,  a 
distance  of  only  275  miles.2 

Other  things  equal,  such  roundabout  transportation 
is  uneconomical.3  It  costs  more  to  carry  goods  by  a 
long  than  by  a  short  route  between  two  given  points. 
Assuming  the  same  rate  on  either  line,  the  long  line 
presumably  has  a  less  surplus  as  profit  than  the  short 
line  would  have.  Diversion  of  freight  to  the  long  line, 
therefore,  probably  means  that  the  short  line  loses  a 

1 W.  Z.  Ripley,  Railroads,  Rates  and  Regulation ,  New  York  (Longmans, 
Green  &  Co.),  1912,  pp.  269,  270. 

2  Interstate  Commerce  Reports,  Vol.  VII,  p.  476  (458-480). 

3  Cf.  Ripley,  Railroads,  Rates  and  Regulation,  Chapter  VIII,  where  this  and 
other  transportation  wastes  are  criticized. 


4o  TRANSPORTATION  COSTS  OF  COMMERCE 


larger  profit  than  the  long  line  gains.  Looked  at  from 
the  point  of  view^of  community  economy,  it  means  that 
a  greater  amount  of  labor  is  used  to  secure  a  result 
which  a  smaller  amount  of  labor  would  equally  well 
secure.  This  greater  amount  of  labor  is  less  profitably 
employed  than  it  might  be,  with  resulting  loss  in  the 
total  of  the  community’s  wealth.  As  in  the  case  of  the 
protective  tariff,  labor  is  employed  where  it  does  not 
yield  the  maximum  return  to  the  community.  It  is 
not,  of  course,  always  the  shortest  line  in  miles  which 
is  most  economical.  The  shortest  line  may  be  one 
which  has  relatively  steep  grades  and  so  requires  more 
labor  and  fuel  than  a  longer  one.  As  between  two 
lines  of  equal  length,  the  choice  should  ordinarily  fall 
upon  the  more  level ;  while  as  between  two  lines  of 
equal  grades,  the  choice  should  ordinarily  fall  upon  the 
shorter.  For  the  same  reasons,  it  is  desirable,  other 
things  equal ,  that  a  place  should  have  goods  brought 
to  it  from  the  nearest  source  of  production  and  that 
centers  of  production  should  send  their  goods  to  the 
nearest  markets.  This,  of  course,  may  be  very  un¬ 
desirable  when  other  things  are  not  equal.  It  may  be 
better  that  goods  be  brought  from  a  far  cheap  source 
than  from  a  near-by  dear  one.  But  where  production 
costs  are  equal,  transportation  costs  should  be  the  least 
possible. 

§  2 

Circumstances  which  May  Make  Carriage  of  Goods  by  a 

Longer  Route  More  Economical  than  their  Carriage  by 

a  Shorter  Route 

There  are,  however,  three  possible  situations,  in  any 
one  of  which  it  may  be  desirable  that  goods  should  be 


COMPETITION  OF  COMPANIES 


4i 


carried  by  a  relatively  long  and  roundabout  route  in¬ 
stead  of  by  a  shorter  and  more  direct  one,  even  though 
grades  are  equal.  To  illustrate  the  first  case  of  this 
sort,  suppose  the  cities  A  and  D  to  be  connected  by  the 
two  railroad  lines  AD  direct  and  A  BCD.  (See  figure  1.) 


Suppose,  also,  that  the  traffic  between  A  and  D  is  more 
than  the  direct  line  AD  can  properly  care  for.  Then 
it  may  well  be  that  the  surplus  traffic,  beyond  what 
the  line  AD  can  carry,  should  go  by  the  indirect  line 
A  BCD,  rather  than  that  a  new  direct  line  should  be 
built  between  A  and  D  or  that  the  line  AD  should  in¬ 
crease  its  trackage.  For  the  construction  of  a  new 
line  or  more  trackage  involves  an  additional  invest¬ 
ment  of  capital.  The  capital  invested  in  the  round¬ 
about  line  A  BCD  has  been  already  sunk  and  cannot 
be  recovered.  If  the  line  A  BCD  yields  any  appreciable 
interest  returns,  it  will  probably  be  worth  while  to 
operate  it,  even  though  these  returns  are  small.  From 
the  point  of  view  of  greatest  national  wealth,  it  is  de¬ 
sirable  that  such  a  plant  should  be  operated,  even  though 
it  would  not  be  desirable,  could  the  choice  be  made  again, 
to  construct  the  plant. 

On  the  other  hand,  the  construction  of  a  new  line  or 


42  TRANSPORTATION  COSTS  OF  COMMERCE 


new  tracks  should  not  be  undertaken  unless  rates  can 
be  charged  which  will  pay  about  the  average  return  on 
investment.  The  old  roundabout  line  may  be  able  to 
make  profit  enough  to  justify  its  continued  operation 
for  a  great  many  years,  on  rates  lower  than  would 
justify  the  construction  of  a  new  line,  even  if  a  more 
direct  one.  The  construction  of  such  a  new  line,  under 
these  circumstances,  would  involve  economic  waste. 
Exactly  the  same  conclusion  may  be  reached  if  we 
assume  that  there  is  no  direct  line  but  only  the  round¬ 
about  line  between  A  and  D  and  that  the  roundabout 
line  is  able  to  carry  the  traffic  between  these  two  points. 
To  the  question  whether  a  direct  line  ought,  under 
such  circumstances,  to  be  constructed,  it  is  not  unlikely 
that  a  correct  answer  would  be  a  negative. 

To  illustrate  the  second  case  where  carriage  of  goods 
by  a  more  roundabout  fine  may  be  desirable,  suppose 
(see  figure  i)  that  there  is  a  great  deal  of  possible  traffic 
between  A  and  D ,  but  that  no  railroad  connecting 
those  points  has  yet  been  built.  The  question  is, 
whether  a  direct  or  an  indirect  line  will  be  the  more 
profitable.  Other  things  equal,  the  direct  route  would 
be  preferred.  But  let  us  suppose  that  B  and  C  are 
thriving  towns,  and  that  the  traffic  to  and  from  each 
can  be  greatly  developed,  while  on  a  direct  line  from 
A  to  D ,  no  other  towns  are  located.  On  this  supposi¬ 
tion,  a  direct  line,  if  constructed,  must  be  able  to  earn 
enough  on  the  through  traffic  between  A  and  D ,  to  pay 
not  only  production-of-train-mileage  expenses  and  ter¬ 
minal  expenses,  but  also  all  of  its  general  expenses  and 
profits.  To  do  this  and  yield  profits  worth  building 
for,  it  may  have  to  charge  fairly  high  rates.  If  a  round¬ 
about  road  is  built,  through  B  and  C,  it  will  have  the 


COMPETITION  OF  COMPANIES 


43 


local  traffic  between  A  and  B,  between  B  and  C,  and 
between  C  and  D ,  as  well  as  the  through  traffic  between 
A  and  D.  The  local  traffic  will  presumably  help  to 
pay  general  expenses  and  interest  or  profits  on  the 
investment.  The  local  traffic  may,  in  fact,  pay  enough 
to  cover  all  the  general  expenses  and  almost  enough  to 
justify,  even  with  no  other  sources  of  revenue  in  view, 
the  construction  of  the  road.  If  the  road  is  built, 
rates  can  be  made  on  the  through  traffic  between  A 
and  D,  which  yield  very  little  more  than  is  required  to 
cover  additional  production-of-train-mileage  costs  and 
terminal  costs;  yet  this  little  more  will  make  the  road 
a  paying  proposition.  Even  though  freight  from  A 
to  D  or  vice  versa  would  have  to  be  carried  a  longer 
distance  on  this  road,  it  may  be  possible  to  carry  it  for 
lower  rates  than  would  pay  all  expenses,  including 
general  expenses,  and  including  also  a  fair  profit,  on  a 
more  direct  road.  Yet  without  the  through  traffic 
between  A  and  D ,  the  line  A  BCD  might  not  be  able  to 
make  an  average  profit,  or  it  might  be  able  to  make 
such  a  profit  only  by  charging  higher  rates  on  its  local, 
short-distance  business.  If,  then,  a  more  indirect  line 
can  carry  goods  more  cheaply  between  A  and  D  than  a 
direct  one,  while  making  no  less  a  per  cent,  or  a  greater 
per  cent,  profit,  and  while,  perhaps,  being  able  to  make 
lower  rates  on  its  intermediate  traffic  than  would  other¬ 
wise  be  necessary,  the  former  is  the  more  economical 
route  to  select.1  If  the  indirect  route  is  chosen,  the 


1  If,  however,  both  a  direct  and  a  roundabout  line  already  exist  between  A  and 
D  and  it  is  merely  a  question  of  constructing  a  new  line  or  additional  trackage, 
because  of  insufficiency  of  the  existing  plants,  then  whether  the  direct  or  the 
indirect  route  would  be  economically  preferable  will  depend  upon  the  relative 
amounts  of  intermediate  and  through  traffic.  If  the  existing  roundabout  road 
can  handle  all  the  intermediate  traffic,  i.e.  the  traffic  from  A  to  B,  from  B  to  C, 


44  TRANSPORTATION  COSTS  OF  COMMERCE 


additional  labor  necessary  to  carry  the  longer  distance 
traffic  is  less  than  if  a  direct  road  is  constructed  for  the 
longer  distance  traffic  alone.  The  same  principle  may 
apply  if  the  more  direct  line  can  hope  to  secure  some 
intermediate  traffic,  but  considerably  less  than  the 
other.  The  same  principle  may  apply,  also,  if  the 
direct  railroad,  AD ,  though  able  to  carry  all  the  local 
or  intermediate  traffic  available  along  its  line,  is  never¬ 
theless  inadequate,  without  the  construction  of  one  or 
more  additional  tracks,  to  carry,  besides,  all  the  traffic 
seeking  to  go  the  entire  distance  from  A  to  D  and  from 
D  to  A.  In  such  a  case,  the  additional  track  or  tracks 
on  this  more  direct  route,  if  constructed,  would  be 
solely  for  the  sake  of  the  longer  distance  traffic,  and 
to  lay  them  would  be  uneconomical  unless  the  longer 
distance  traffic  would  alone  yield  a  reasonable  profit 
on  the  additional  capital  investment  required.  Sup¬ 
posing  that  a  roundabout  line,  through  B  and  C,  had 
not  previously  been  built,  and  that,  if  constructed, 
such  a  line  could  be  largely  supported  by  intermediate 
traffic,  while  yet  being  able  to  carry  some  of  the  longer 
distance  traffic  also,  the  roundabout  line  might  be  a 
more  economical  and  more  profitable  investment  of 
capital  than  additional  trackage  along  the  direct  line. 
i  The  third  case  to  be  here  considered  is  a  case  where 
the  lines  A  BCD  and  AD  (see  again  figure  i)  have  both 

from  C  to  A,  etc.,  and  the  inadequacy  of  facilities  is  due  solely  to  the  excess  of  the 
A  to  D  and  D  to  A  traffic  over  what  the  direct  road  can  carry,  additional  con¬ 
struction  along  the  more  direct  route  would  almost  certainly  be  the  more  eco¬ 
nomical  investment  of  capital.  Rather  than  lay  additional  tracks,  the  round¬ 
about  line  should,  perhaps,  under  such  circumstances,  resign  all  through  traffic 
and  confine  itself  to  intermediate  traffic.  But  if  additional  trackage  must  be 
constructed  by  the  roundabout  line  for  the  intermediate  traffic,  and  if  such  addi¬ 
tional  trackage  will  also  serve  for  the  carriage  of  some  of  the  through  traffic,  the 
roundabout  line  may  be  economically  justified  in  carrying  both. 


COMPETITION  OF  COMPANIES 


45 


been  built,  but  where  the  traffic  between  A  and  D  is 
not  more  than  can  be  taken  care  of  by  one  of  the  roads 
alone.  Not  only  is  there  no  need  for  new  construction, 
but  already  existing  facilities  are  in  excess  of  business. 
Unless  more  traffic  is  to  be  hoped  for  in  future,  it  will 
be  the  truest  economy  to  abandon  one  of  the  roads. 
Otherwise  the  community  must  be  burdened  with  two 
sets  of  general  expenses  and  must  in  so  far  lose  the 
economy  that  comes  from  complete  utilization  of  a 
transportation  plant.1  If  other  things  are  equal,  the 
conclusion  will  be  that  the  more  roundabout  road  should 
be  the  one  to  be  abandoned.  But,  as  in  the  second 
case,  other  things  may  be  unequal.  The  roundabout 
road  may  be  able  to  rely  upon  intermediate  traffic 
which  the  more  direct  road  cannot  hope  to  secure. 
In  that  case,  the  direct  road  AD  cannot  afford  long  to 
operate  unless  the  through  traffic  between  A  and  D 
can  bear  rates  high  enough  to  cover  most  or  all  of  the 
general  expenses  of  the  road.  But  the  road  A  BCD 
has,  by  hypothesis,  intermediate  traffic  to  and  from 
B  and  C,  and  this  intermediate  traffic  may  possibly  be 
considerable  enough  to  pay  all  the  general  expenses 
of  the  road  and  something  towards  profits.  It  may  be 
worth  while  to  operate  the  road  A  BCD  even  without 
any  of  the  through  traffic  between  A  and  D ,  or  with 
rates  on  this  through  traffic  barely  above  the  additional 
production-of-train-mileage  costs  and  terminal  costs 
necessary  to  move  it.  The  roundabout  road  may 
therefore  be  able  to  make  lower  rates  on  through 
traffic  between  A  and  D  than  the  direct  road  could 

1  This  saving  has  been  already  in  part  lost,  when  the  unnecessary  line  has 
been  constructed,  since  capital  which  might  have  earned  a  fair  return  has  been 
put  where  it  cannot  do  so. 


46  TRANSPORTATION  COSTS  OF  COMMERCE 


possibly  afford  to  make,  even  though  the  former  must 
carry  the  goods  longer  distances;  and  may  yet  be  a 
more  profitable  investment  for  its  owners  than  the 
latter  could  hope  to  be  without  charging  higher  rates. 
It  may  sometimes,  therefore,  be  truer  economy  to 
abandon  the  direct  than  to  abandon  the  roundabout 
line  between  two  given  points. 

An  illustration  of  a  movement  of  traffic  in  part  by 
relatively  indirect  routes  is  furnished  by  the  import 
and  export  trade  of  the  United  States.  Goods  are 
carried  to  Chicago  and  other  middle  western  cities  from 
Europe,  and  from  the  great  grain-raising  sections  of 
the  United  States  to  Europe,  by  various  transportation 
routes,  and  not  always  by  the  shortest.  All  the  im¬ 
portant  ports  and  the  railroads  and  steamship  lines 
serving  these  different  ports  are  in  competition  for  this 
traffic.  Wheat  may  be  carried  due  south  to  New  Or¬ 
leans,  or  southeast  to  Galveston,  and  thence  to  Europe, 
instead  of  going  east  through  Baltimore,  Boston,  or 
New  York.  If  a  railroad  from  the  American  wheat 
and  corn  regions  to  Norfolk,  Newport  News,  Galveston, 
or  New  Orleans  is  useful  for  domestic  commerce,  and 
can  add  anything  to  its  profits  by  engaging  at  lower 
rates  in  export  and  likewise  import  trade,  it  may  be  as 
well  or  better  that  such  a  railroad  should  engage  in 
this  trade,  as  that  the  New  York  Central  and  the  Penn¬ 
sylvania  systems  should  enlarge  their  plants  so  as  to 
do  more  of  export  and  import  business.  The  different 
ports  and  railroads  concerned  in  this  business  have  on 
many  occasions  engaged  in  contests  to  secure,  each,  a 
larger  share  of  the  trade.  These  contests  can  only  be 
satisfactorily  settled  by  such  an  agreed  relation  of  rates 
as  will  secure  to  each  road  a  quota  of  the  business. 


COMPETITION  OF  COMPANIES 


47 


The  Interstate  Commerce  Commission  itself,  when  en¬ 
deavoring  to  settle  such  a  contest,  has  been  able  to 
find  no  better  basis  than  this.1 

The  conclusions  we  have  reached,  should,  it  is  be¬ 
lieved,  have  some  weight  against  any  proposal  to  prohibit 
absolutely  the  competition  of  roundabout  lines.  We 
have  seen  that  there  are  possible  cases  where  a  round¬ 
about  line  may  more  profitably  be  built  for  the  traffic 
between  two  points  than  a  direct  one.  Yet  if  the 
builders  know  in  advance  that  they  will  not  be  allowed 
to  compete  against  a  direct  one,  should  the  latter  be 
constructed,  they  will  be  less  apt  to  build  the  round¬ 
about  line.  Undoubtedly  there  are  wastes  of  competi¬ 
tion  in  the  form  of  uneconomical  carriage  of  goods  over 
unduly  long  routes  to  destination,  and  some  legal  limi¬ 
tation  on  these  wastes  may  be  desirable.  Yet  on  the 
other  hand,  as  we  have  seen,  it  is  not  necessarily  always 
the  shortest  line  which  is  really  the  most  economical  for 
the  purpose.  Furthermore,  the  stimulus  of  competition 
between  rival  routes  is  not  altogether  without  beneficial 
effects  in  hastening  improvement,  increasing  efficiency, 
and  keeping  down  average  rates.  The  Interstate  Com¬ 
merce  Law  of  the  United  States  penalizes  the  competi¬ 
tion  of  roundabout  lines  by  forbidding  rates  on  inter¬ 
mediate  traffic,  e.g.  from  A  to  C  in  our  figure,  higher 
than  rates  on  longer  distance  traffic  over  the  same  line 
in  the  same  direction,  the  shorter  haul  being  included 
in  the  longer;  though  the  rigor  of  this  section  (4)  of 
the  law  is  lessened  by  the  power  of  the  Interstate  Com¬ 
merce  Commission  to  set  it  aside  on  application  of  the 
common  carrier  concerned,  in  cases  where  such  a  ruling 

1  See  Interstate  Commerce  Reports,  Vol.  XI,  pp.  13-81,  particularly  pp. 
62,  63. 


48  TRANSPORTATION  COSTS  OF  COMMERCE 


seems  proper,  and  to  whatever  extent  circumstances 
seem  to  warrant.  An  application  of  this  law  or  of  its 
principle  of  limitation,  which  should  require  of  the 
straightest  line  between  two  points,  strict  conformity 
to  the  law  as  now  worded,  and  which  should  allow  to 
more  roundabout  lines,  in  some  cases,  a  percentage 
departure  from  this  rule,  might  satisfactorily  meet  the 
difficulty.1  A  more  roundabout  line  might  be  allowed 
to  depart  from  the  rule  by  a  larger  per  cent,  than  one 
less  roundabout,  since  otherwise  reduction  of  its  rates 
on  goods  going  over  the  long  distance  might  require 
so  great  reductions  on  its  intermediate  traffic  as  to 
deprive  it  of  revenue.  Yet  after  a  certain  degree  of 
roundaboutness  had  been  reached,  further  increase  of 
the  allowed  percentage  departure  from  the  rule  might 
properly  be  refused,  since  an  undue  difference  would 
mean  either  that  the  long-distance  traffic  was  being 
carried  for  less  than  the  additional  cost  occasioned,  or 
that  the  intermediate  traffic  was  being  charged  exor¬ 
bitant  rates. 

The  solution  here  suggested  would  not  do  away  with 
all  uneconomical  roundabout  carrying  of  goods,  but  • 
neither  would  it  do  away  with  the  stimulus  of  competi¬ 
tion.  It  may  be  better  to  have  competition  even  with 
the  economic  waste  inseparable  from  it,  than  not  to 
have  competition  at  all.  No  government  rate  regula¬ 
tion  can  ever  stimulate  progress  as  competition  does, 
even  if  it  can  successfully  prevent  the  enjoyment  of 
monopoly  profits.  If  the  percentage  of  deviation  from 
the  long  and  short  haul  rule  were  properly  arranged,  no 
road  would  have  any  unfair  advantage  over  any  other, 
and  competition,  so  far  as  it  existed,  would  influence 

1  For  further  discussion  along  this  line,  see  Chapter  V  (of  Part  III),  §  x. 


COMPETITION  OF  COMPANIES 


49 


intermediate  as  well  as  strictly  competitive  traffic. 
An  administrative  body  such  as  the  Interstate  Com¬ 
merce  Commission,  may  well,  perhaps,  have  power  to 
decide  in  each  case,  in  view  of  all  the  circumstances, 
the  extent  of  departure  from  the  rule  which  ought 
to  be  allowed,  and  the  amended  Federal  law,  as 
above  stated,  specifically  gives  to  the  Commission  this 
power.1 

In  the  case  of  ocean  transportation,  there  is,  as  has 
been  pointed  out,2  no  expense  for  construction  or  main¬ 
tenance  of  way.  It  would  therefore  never  be  worth 
while  to  abandon  a  more  direct  route  in  order  to  save 
expense  of  upkeep.  Unless  winds  or  currents,  etc., 
interfered,  full  cargoes  shipped  at  one  point,  and  des¬ 
tined  to  another,  would  ordinarily  go  direct,  though 
two  or  more  available  routes  may,  not  infrequently, 
be  equally  short  or  otherwise  equally  favored  by 
nature.  A  somewhat  roundabout  route  may  sometimes 
be  chosen  for  the  sake  of  intermediate  traffic,  espe¬ 
cially  in  cases  where  through  traffic  will  not  by  itself 
provide  full  cargoes  sufficiently  often  to  justify  the 
frequency  of  service  desired  by  shippers.  Also,  a 
roundabout  line,  whose  vessels  are  mainly  but  not 
quite  utilized  by  intermediate  traffic,  will  sometimes 
enter  into  competition  with  a  direct  line  for  through 
traffic,  in  order  to  carry  more  nearly  full  cargoes.  Sail¬ 
ing  vessels  frequently  follow  indirect  routes  to  avoid 
regions  of  calm  and  of  unfavorable  winds,  but  in  such 
cases  the  route  which  is  long  in  miles  may  be  the 
shortest  in  time. 

1  Its  exercise  has  recently  been  upheld  by  the  Supreme  Court.  See  Inter¬ 
mountain  Rate  Cases,  234  U.  S.,  476. 

*  Chapter  I  (of  Part  III),  §  6. 


PAM  HI  —  E 


50  TRANSPORTATION  COSTS  OF  COMMERCE 

§3 

Competition  of  Directions 

The  third  kind  of  competition  which  we  have  to 
consider  is  competition  of  directions.1  To  make  clear 
what  conditions  must  exist  in  order  that  there  should 
be  competition  of  directions,  we  shall  begin  with  an 
assumed  case  where  such  competition  hardly  exists 
in  any  significant  degree.  Suppose  two  roads  leading 
from  A,  which  we  shall  assume  to  be  a  center  of  coal 
mining,  one  to  B  and  the  other  to  C  (figure  2).  If 


the  roads  AB  and  AC  should  compete  strenuously,  each 
endeavoring  to  carry  the  coal  over  its  own  line  to  B 
and  to  C  respectively,  we  should  have  here  an  example 
of  competition  of  directions.  But  unless  we  make  further 
assumptions,  there  is  little  basis  for  a  conclusion  that 
such  competition  would  take  place.  Neither  road  need 
reduce  its  rate  on  the  coal  to  a  competitive  level  even 

1  This,  and  the  kind  of  competition  next  to  be  considered,  are  generally  lumped 
together  with,  it  is  believed,  inadequate  analysis,  under  the  head  of  competition 
of  and  for  markets.  See,  for  example :  Noyes,  American  Railroad  Rates,  Boston 
(Little,  Brown,  &  Co.),  1906,  pp.  125,  126;  Johnson,  American  Railway  Trans¬ 
portation,  2d  revised  edition,  New  York  (Appleton),  1909,  p.  265;  Ripley, 
Railroads,  Rates  and  Regulation,  pp.  118-123. 


COMPETITION  OF  COMPANIES 


5i 


if  the  other  road  does  so,  and  neither  is  likely  to  gain 
but  is  rather  likely  to  lose  from  taking  the  initiative  in 
such  reduction.  Suppose  the  road  AB  to  make  low 
rates  on  coal  to  B.  It  does  not  follow  that  the  road 
AC  must  make  low  rates  to  C  or  lose  the  traffic.  It  is 
true  that  the  producers  at  A  will  prefer  to  ship  their 
coal  to  the  market  which  will  yield  them,  after  sub¬ 
traction  of  transportation  expenses,  the  largest  return. 
But  the  people  at  C  will  presumably  need  coal,  and  if 
the  road  AC  has  a  monopoly  to  that  point,  it  can  prob¬ 
ably  continue  to  charge  a  high  rate  and  still  get  large 
traffic.  The  people  at  C  will  have  to  pay  a  high  enough 
price  to  cover  this  transportation  expense  and  induce 
producers  at  A  to  send  them  the  coal.  The  road  AB 
will  not  succeed  in  diverting  much  more  than  previously 
of  the  output  of  A,  to  the  point  B,  and  therefore,  since 
its  rates  are  lower,  will  suffer  a  reduction  of  its  revenues.1 

Let  us  now  consider  a  situation  in  which  competition 
of  directions  might  accomplish  something  appreciable 
for  the  community.  Suppose,  as  before,  two  roads 
leading,  one  from  A  to  B  and  the  other  from  A  to  C. 
But  suppose  that  both  B  and  C  are  in  part  supplied 
with  coal  by  competing  roads  leading  from  other  coal- 
producing  sections  than  A,  namely,  from  D  and  E 
respectively.  (See  figure  3.)  We  may  suppose,  also, 
that  the  annual  coal  production  of  A  is  not  sufficient 
to  satisfy  completely  both  of  the  markets  B  and  C. 
In  this  situation,  the  lines  AB  and  AC  can  charge  high 
rates  only  by  combination  or  agreement  with  each 
other  and  at  the  expense  of  producers  at  A.  The  price 


1  The  possibility  that  B  may  be  built  up  and  that  industries  may  desert  C, 
and  the  consequent  effects  on  the  revenues  of  the  roads,  will  be  discussed  with  a 
consideration  of  the  fourth  kind  of  competition,  that  of  locations. 


52  TRANSPORTATION  COSTS  OF  COMMERCE 

of  coal  at  B  and  likewise  at  C,  because  of  the  supply 
from  another  source  or  sources  than  A ,  cannot  exceed, 
say,  $5  a  ton.  High  railroad  rates  from  A,  e.g.  $3  a 
ton,  cannot  force  consumers  at  B  and  C  to  pay  more 
than  $5,  and  must,  therefore,  result  in  a  return  of  not 
more  than  $2  per  ton  to  producers  at  A.  But  if  the 
line  AB,  for  example,  reduces  its  rate  from  $3  to  $1,  in 
order  to  encourage  larger  shipments  of  coal  from  A  to 
B,  then  the  line  AC  must  reduce  its  rate  on  coal  carried 


from  A  to  C,  or  forego  most  of  the  business.1  The  line 
AC  cannot  continue  to  enjoy  high  rates  on  coal  shipped 
from  A  to  C,  by  imposing  a  higher  price  for  coal  on 
consumers  at  C,  since  competition  of  lines  from  E  to  C 
insures  these  consumers  a  price  not  above  $5  a  ton. 
Neither  can  AC  impose  the  expense  of  $3  per  ton  rates, 
upon  producers  at  A,  thus  keeping  their  net  returns 
down  to  $2  per  ton,  since,  if  AC  attempts  this,  producers 

1  Unless  we  suppose  that  the  output  at  A  is  considerably  increased,  so  as  to 
leave  a  surplus  for  the  high  rate  road  even  after  a  low  rate  by  the  other  has 
diverted  the  former  output.  But  it  is  not  to  be  supposed  that  capital  will  be 
rushed  to  A  and  the  poorer  mines  previously  unused  be  suddenly  exploited,  for 
no  better  returns  than  could  be  had  before. 


COMPETITION  OF  COMPANIES 


53 


at  A  will  ship  most  or  all  of  their  coal  to  B,  over  the 
line  AB ,  receiving  about  $5  a  ton  at  B,  paying  $1  a 
ton  freight,  and  having  a  net  return  of  $4  a  ton  at  the 
mines.1  There  is  competition  of  directions  because  the 
coal  produced  at  A  will  go,  in  the  main,  to  B  or  to  C 
according  to  the  rates  made  by  the  rival  roads  AB  and 
AC,  leading  in  different  directions  from  the  same  pro¬ 
ducing  center. 

Let  us  consider  another  possible  situation.  Suppose 
coal  to  be  produced  at  A  and  at  D  and  to  be  marketed 


B 


C 


Figure  4 

at  B  and  C  over  the  railroads  AB,  DB ,  ^4C,  and  DC. 
(See  figure  4.)  Suppose  that,  at  first,  each  of  the  roads 
is  charging  $3  a  ton  to  carry  the  coal  either  from  A  or 
from  D  to  either  B  or  C.  The  price  of  coal  at  B  and 
at  C  is  $6  a  ton,  and,  therefore,  at  the  sources  of  produc¬ 
tion,  A  and  D,  it  is  $3  a  ton.  One  of  the  roads,  for 

1  In  practice,  the  extra  supply  of  coal  at  B  would  tend  to  lower  its  price  there 
somewhat  below  $5  and  to  lower  the  returns  at  A  somewhat  below  $4.  But  the 
change  in  figures  involved  does  not  change  the  essential  principle  of  the  case. 


54  TRANSPORTATION  COSTS  OF  COMMERCE 


example,  the  road  AC,  reduces  its  rate  to  $2,  hoping 
thereby  to  get  more  of  the  business.  We  have  to  in¬ 
quire  whether  such  an  action  will  force  reduction  on 
any  or  all  of  the  other  roads. 

The  effect  of  the  reduction  by  ^4C  will  be  different 
according  as  the  benefit  goes  mainly  to  the  producers 
at  A,  or  to  the  consumers  at  C,  or  is  divided  more  or 
less  equally  between  them.  Suppose,  first,  that  the 
benefit  goes  almost  entirely  to  producers  at  A,  these 
producers  receiving  about 1  $4  instead  of  $3  per  ton 
for  all  coal  shipped  to  C,  and  the  price  at  C  remaining 
substantially  unchanged.  Then  (assuming  a  limited 
annual  production  at  A)  the  line  AB  would  have  to 
lower  its  rate  between  A  and  B  to  about  $2.  For 
otherwise,  most  of  the  coal  mined  at  A  would  be  shipped 
to  C,  instead  of  the  shipments  being  divided  between 
B  and  C.  Since  the  price  at  B  is,  by  hypothesis,  $6, 
and  the  rate  to  B  $3,  the  miners  at  A  would  get  only 
$3  net  on  coal  shipped  to  B  as  compared  with  nearly 
$4  on  coal  shipped  to  C.  The  road  AB  would,  there¬ 
fore,  have  to  reduce  or  lose  the  business. 

Suppose,  second,  that  the  benefit  of  the  rate  reduction 
by  AC  goes  almost  entirely  to  the  consumers  at  C, 
in  the  form  of  lower  prices  for  coal,  coal  selling  at  C 
for  little  above  2  $5  instead  of  for  $6  a  ton.  The  reduc- 


1  Probably  not  quite  $4,  for  the  greater  amount  of  coal  shipped  to  C  in  con¬ 
sequence  of  the  reduced  rate  would  almost  certainly  reduce  the  price  somewhat. 
Yet  this  reduction  of  price  might  conceivably  be  small,  because  of  an  elastic 
demand  at  and  about  C,  and  because  a  small  reduction  of  price  might  discourage 
and  decrease  shipments  of  coal  to  C  from  D. 

s  Probably  somewhat  more  than  $5,  because  the  better  market  for  4’s  coal 
would  be  almost  certain  to  affect  its  price  somewhat.  Nevertheless,  an  inelastic 
demand  at  C,  coupled  with  the  shipping  of  somewhat  more  of  .4’s  output  to  C, 
might  well  result  in  the  consumers  at  C  reaping  most  of  the  gain  from  the  lower 
transportation  rate  on  coal. 


COMPETITION  OF  COMPANIES 


55 


tion  by  the  line  AC  may  then  force  an  equivalent  re¬ 
duction  by  the  line  DC.  Since  coal  from  D  can  no 
longer  sell  at  C  for  $6  a  ton,  either  the  coal  producers 
at  D  must  accept  substantially  $i  less  on  the  coal  sent 
by  them  to  C,  namely,  $2  instead  of  $3  per  ton,  or  the 
railroad  DC  must  reduce  its  transportation  charge  from 
$3  to  about  $2.  But  the  coal  producers  at  D  will  not 
be  likely  to  accept  a  much  lower  price  at  the  mine 
than  $3  for  coal  shipped  to  C,  so  long  as  they  can  ship 
coal  to  B  at  a  rate  of  $3  and  sell  it  there  for  $6  a  ton. 
Unless  the  market  at  B  is  decidedly  limited  (or  the  out¬ 
put  of  D  too  great  to  be  mostly  sold  there)  the  line 
DB  will  be  an  effective  competitor  of  the  line  DC , 
for  the  traffic  from  D,  and  if  the  price  of  coal  at  C 
falls,  while  that  at  B  does  not,  the  line  DC  must  reduce 
its  rate  or  lose  much  or  most  of  its  coal  traffic.  It 
would  be  a  superficial  statement  to  say  merely  that  we 
have  here  a  competition  of  the  lines  ^4C  and  DC  for  the 
market  at  C.  For  DC  would  not  be  under  the  same 
compulsion  that  it  is  under  to  lower  rates,  were  it  not 
for  the  line  DB  and  the  alternative  market  of  D  coal 
at  B.  DC’s  competition  is,  therefore,  equally  a  compe¬ 
tition  with  the  line  DB,  and  may  be  classified  with 
other  cases  of  competition  of  directions.  The  coal 
produced  at  D  has  a  choice  of  the  directions  DC  and 
DB  towards  the  two  possible  markets. 

Suppose,  third,  that  the  benefit  of  the  reduced  rate 
made  by  ^4C  goes  about  half  to  the  producers  at  A 
and  half  to  the  consumers  at  C.  Producers  at  A  get 
$3.50  instead  of  $3  per  ton  at  the  mine;  and  consumers 
at  C  have  to  pay  only  $5.50  instead  of  $6  a  ton.  On 
this  supposition,  the  line  DC  will  have  to  reduce  its 
rate  to  $2.50  to  meet  the  lower  price  of  coal  at  C.  Other- 


56  TRANSPORTATION  COSTS  OF  COMMERCE 


wise,  i.e.  if  the  loss  from  the  lower  price  at  C  is  thrown 
upon  those  producers  at  D  who  ship  coal  to  C,  no  coal 
miners  at  D  will  send  any  of  their  product  to  C,  but 
will  send  it,  instead,  to  B.  The  possibility  that  the 
coal  will  go  in  this  other  direction,  i.e.  to  B ,  compels 
the  road  DC  to  reduce  its  rate  50  cents.  Also,  the 
road  AB  will  have  to  reduce  its  rate  to  $2.50.  For 
producers  at  A  receive  a  net  return  of  $3.50  on  coal 
sent  to  C.  With  coal  selling  at  B  for  $6  and  with  a 
$3  rate  to  B,  they  would  receive  but  $3  net  on  coal 
sent  to  B.  They  would,  therefore,  send  little  or  no 
coal  to  B  unless  the  road  AB  reduced  its  rate  to  about 
$2.50.  If  the  benefit  of  ^4C’s  reduction  is  divided 
about  equally,  then,  between  producers  at  A  and  con¬ 
sumers  at  C,  the  roads  DC  and  AB  may  each  be  forced 
to  make  a  reduction  about  half  that  made  by  AC. 
The  rates  charged  by  DB  would  not  have  to  be  lowered 
unless  DC  ox  AB  made  a  further  reduction,  or  unless 
the  road  DB  desired  more  traffic  than  before. 

The  situation  is  no  different  if  the  original  reduction 
on  the  line  AC  results,  not  from  a  desire  to  secure  more 
traffic,  but  from  an  order  of  a  government  regulating 
body  such  as  the  Interstate  Commerce  Commission. 
In  either  case,  the  other  road  or  roads  affected  must 
also  make  a  reduction  or  lose  traffic.  It  follows  that 
regulation,  directly,  of  the  rates  of  one  railroad  may 
affect  and  frequently  does  affect,  indirectly,  the  rates 
charged  on  a  number  of  other  railroads. 

One  other  hypothetical  illustration  of  competition  of 
directions  will  be  given.  Let  us  suppose  A  and  C  to 
be  connected  with  each  other  by  the  single  line  AC 
(figure  5) ;  but  suppose  that  the  competition  of  two 
lines  from  A  to  B  (or  government  regulation  of  their 


COMPETITION  OF  COMPANIES 


57 


rates)  fixes  a  minimum  price  below  which  coal  producers 
at  A  need  not  sell,  and  that  the  competition  of  two  lines 
from  D  to  C  fixes  a  maximum  price  on  coal  for  consumers 
at  C.  The  line  AC  must  make  a  rate  low  enough  to 
give  the  producers  at  A  as  high  a  price  as  they  can  get 
by  shipping  to  B ,  and  to  give  the  consumers  at  C  as 
low  a  price  on  coal  from  A  as  they  have  to  pay  on  coal 


Figure  5 


from  D.  Otherwise,  the  line  AC  will  get  no  business 
and  the  coal  produced  at  A  will  be  carried  to  B.  The 
line  AC  may  be  said  to  compete  with  the  lines  from 
D  to  C,  for  the  market  at  C;  and  to  compete  with  the 
lines  from  A  to  B,  in  order  to  carry  coal  produced  at 
A  over  its  line  in  the  direction  of  C.  It  is  situations 
of  this  general  nature  which  justify  the  statement 
sometimes  made  by  railroad  men  that  they  cannot 
make  rates,  but  merely  put  in  force  rates  made  by 
commercial  conditions.  Nevertheless,  the  so-called  com¬ 
mercial  conditions  which  do  determine  these  rates  are 
likely  to  prove,  on  analysis,  to  be  competitive  conditions, 


58  TRANSPORTATION  COSTS  OF  COMMERCE 

as  here  shown,  and  to  be  controllable  in  so  far  as  com¬ 
petition  can  be  controlled. 

It  is  not  difficult  to  find  real  cases  where  railroads 
are  in  one  or  more  of  such  situations  as  have  been  de¬ 
scribed  in  this  section,  and  are  therefore  subject  to 
competition  of  directions.  Consider,  for  instance,  the 
position  of  lines  leading  from  various  Michigan  and 
Kansas  salt-producing  points  to  different  and  the  same 
markets,  as  brought  out  in  a  recent  case  before  the 
Interstate  Commerce  Commission.1  A  number  of  trans¬ 
portation  lines,  rail  and  water,  lead  from  Michigan  salt- 
producing  points  to  various  markets,  and  among  others, 
to  markets  west  and  southwest  of  Michigan,  on  the 
Mississippi  River.  To  these  same  points  on  the  Mis¬ 
sissippi  River,  salt  is  brought  over  different  lines,  east 
and  northeast,  from  the  Kansas  salt  fields.  The  Mis¬ 
sissippi  River  lies  about  midway  between  the  Michigan 
and  the  Kansas  centers  of  salt  production.  Points  on 
the  Mississippi,  and  other  points,  farther  west,  as  wrell, 
may  be  supplied  with  salt  from  the  Kansas  or  from  the 
Michigan  fields  and,  in  fact,  from  different  production 
centers  in  either  of  those  states.  On  the  other  hand, 
many  of  the  salt-producing  centers  have  the  option  of 
shipping  salt  over  any  one  of  several  transportation  lines, 
either  to  several  of  the  towns  on  the  Mississippi  River, 
or  to  other  points  in  the  same  or  different  directions. 
Here,  then,  are  all  the  conditions  for  competition  of 
directions.  Traffic  from  a  given  producing  center, 
e.g.  Detroit,  Michigan,  would  meet  like  goods  from 
another  producing  center,  e.g.  Hutchinson,  Kansas,  or 
some  Michigan  point  other  than  Detroit,  in  a  common 

1  Interstate  Commerce  Commission  Reports,  Vol.  XXII,  pp.  407-419,  case 
decided  February,  1912. 


COMPETITION  OF  COMPANIES 


59 


market,  St.  Louis.  If  the  Wabash  Railroad,  leading 
from  Detroit  to  St.  Louis,  refused  to  make  reasonably 
low  rates,  it  would  find  itself  with  less  traffic  or  with¬ 
out  traffic  in  salt.  Rather  than  bear  the  burden  of  the 
higher  rate,  St.  Louis  dealers  would  secure  salt  from 
Hutchinson 1  or  other  Kansas  points  or  from  some 
Michigan  point  other  than  Detroit,  e.g.  from  Manistee 
or  Ludington,  and,  therefore,  over  other  transportation 
lines  than  the  Wabash.  Rather  than  accept  less  for 
their  salt  by  virtue  of  the  higher  railroad  rate,  the  salt 
producers  of  Detroit,  being  so  situated  as  to  have  this 
option,  would  prefer  to  ship  their  salt  in  another  direc¬ 
tion  and  to  a  different  market,  for  example,  by  way  of 
a  lake  route  to  Toledo,  Cleveland,  or  Chicago.  As  a 
matter  of  fact,  most  of  the  Michigan  salt,  perhaps  80 
per  cent.,  is  shipped  in  the  first  instance  by  water.  In 
view  of  all  these  conditions,  not  to  mention  others  more 
properly  connected  with  competition  of  locations,  the 
Wabash  Railroad  has  found  itself  compelled  to  make 
rates  on  salt  from  Detroit,  in  reasonable  relation  to  the 
rates  made  by  these  various  competitors. 

We  have  an  illustration  of  what  is  probably,  in  part, 
competition  of  directions  involving  ocean  carriers,  in 
the  export  trade  from  the  United  States  to  South  and 
East  African  ports.  The  rates  charged  are  said  to  be 
maintained,  as  nearly  as  possible,  on  the  same  level  as 
the  rates  from  British  and  continental  ports.2  But 

1  If  from  Hutchinson,  the  Wabash  might  carry  it  part  of  the  distance,  but  a 
much  less  distance  than  if  from  Detroit.  But  at  St.  Louis,  the  Wabash  has 
particularly  to  fear  competition  from  other  Michigan  sources  of  supply,  not  on 
its  own  line. 

2  Huebner,  Report  on  Steamship  Agreements  and  Affiliations  in  the  American 
Foreign  and  Domestic  Trade,  in  Proceedings  of  the  Committee  on  the  Merchant 
Marine  and  Fisheries  in  the  Investigation  of  Shipping  Combinations,  1914. 
Vol.  IV,  p.  93. 


6o  TRANSPORTATION  COSTS  OF  COMMERCE 


why  must  such  rates  be  made?  Is  it  not  largely  be¬ 
cause  otherwise  the  goods  which  these  vessels  might 
carry  from  America  would  be  shipped  by  producers  in 
other  directions  and  to  different  markets,  either  within 
or  outside  of  the  boundaries  of  the  United  States? 
In  other  words,  is  not  one  of  the  most  important  in¬ 
fluences  to  be  considered,  the  fact  that  the  American 
producers  have  an  alternative  of  which  they  will  avail 
themselves  if  not  granted  reasonably  satisfactory  rates? 

We  may,  indeed,  broaden  our  conception  of  competi¬ 
tion  of  directions,  so  as  to  have  it  include  the  making 
of  rates  to  induce  shipment  of  goods  by  producers,  in 
a  given  direction  and  over  given  transportation  lines, 
when  otherwise  some  of  these  producers  would  find  it 
more  profitable  to  engage  in  the  production  of  an  en¬ 
tirely  different  class  of  goods,  marketable  only  in  another 
direction  and  over  other  lines.  Thus,  the  ships  leading 
from  American  ports  to  South  and  East  African  ports 
must  charge  on  American  goods,  marketable  in  Africa, 
reasonable  rates  in  relation  to  rates  charged  from  Europe, 
not  only  because  without  such  rates  the  American  pro¬ 
ducers  might  seek  other  markets  for  those  goods,  but 
also  because  these  producers  might,  to  some  extent, 
decide  to  engage  in  the  production  of  other  goods,  not 
marketable  in  Africa.  For  the  American  producers  to 
choose  this  latter  alternative,  no  less  than  for  them  to 
choose  the  former,  would  mean  diminished  freight  for 
the  America- Africa  lines.  In  the  same  way  the  making 
of  low  rates  by  a  railroad  to  enable  a  manufacturing 
plant  to  market  its  produce  and  so  “  keep  it  in  business,” 
may  often  be,  in  the  last  analysis,  competition  of  this 
sort.  The  persons  operating  the  plant  would  doubt¬ 
less,  in  any  case,  be  engaged  in  some  business,  but  the 


COMPETITION  OF  COMPANIES 


61 


alternative  kind  of  production  might  not  provide  traffic 
for  the  particular  railroad  in  question.1 


Competition  of  Locations 

The  fourth  kind  of  competition  is  competition  of 
locations.  It  is,  by  itself,  perhaps  less  effective  in  pro¬ 
tecting  the  public  against  monopoly  rates  than  any  of 
the  other  three  kinds  of  competition,  and  certainly  less 
effective  than  either  of  the  first  two  kinds.  To  illus- 


Figure  6 


trate  competition  of  locations,  assume  two  railroad 
lines  leading  into  a  common  terminal  city,  A,  the  one 
coming  from  C  through  B,  and  the  other  from  E  through 
D.  (See  figure  6.)  Let  us  suppose  that  B  is  favorably 
located  for  iron  and  steel  production,  being  in  the  center 

1  It  is  not  improbable  that  railroads  sometimes  make  rates  to  maintain  traffic 
in  a  given  kind  of  goods  over  their  lines,  when  the  nearest  alternative  to  the  per¬ 
sons  producing  those  goods  would  be  the  production  of  other  goods  for  shipment 
over  the  same  railroad.  That  this  is  the  nearest  alternative  may  not  be  realized 
by  the  traffic  officials  of  the  railroad. 


62  TRANSPORTATION  COSTS  OF  COMMERCE 


of  a  coal-producing  district,  and  being  able  to  get  iron 
ore  from  C.  The  market  is  largely  in  and  about  A. 
The  point  D  is  no  less  favorably  located  for  iron  and 
steel  manufacture,  there  being  coal  about  D  and  iron 
ore  about  E.  Iron  and  steel  manufacturers  will  locate 
at  D  in  preference  to  locating  at  B ,  provided  they  have 
better  opportunity  at  D ,  because  of  low  transportation 
rates,  to  reach  the  market  A  and  secure  a  satisfactory 
profit.  In  general,  the  original  and  continued  location 
of  an  industry  in  any  center  of  production  depends,  in 
part,  upon  the  transportation  rates  it  can  get,  and 
particularly  upon  the  rates  made  to  markets  where 
competitors  from  other  producing  centers  must  be  met. 
High  rates  to  points  on  the  same  line,  where  the  com¬ 
petition  from  other  sources  of  production  is  not  equally 
to  be  feared  may,  if  necessary,  be  shifted  to  consumers. 
The  industry  may,  therefore,  continue  to  exist  in  a 
given  center  of  production  even  without  low  rates 
into  a  common  market,  because  of  its  sale  in  territory 
which  is  less  competitive ;  but  it  will  not  be  carried  on 
in  that  center  of  production  to  the  same  extent.  In 
this  sense,  the  rates  charged  influence  the  location  of 
the  industry,  i.e.  the  extent  of  its  location  at  any  pro¬ 
ducing  center.  In  our  assumed  case,  the  rate  on  the 
iron  and  steel  products  from  D  to  A  must  be  low  enough, 
along  with  the  rate  on  iron  ore  from  E  to  D,  and,  per¬ 
haps,  on  other  needed  supplies,  machinery,  and  food 
for  workers,  from  both  A  and  E  into  D ,  so  that  con¬ 
ditions  as  a  whole  will  favor  existence  of  the  industry 
at  D  as  well  as  at  B.  Otherwise,  the  line  EDA  may 
find  itself  with  an  unprofitably  light  traffic. 

Yet  this  kind  of  competition  is  likely  to  be  relatively 
unimportant  in  its  effect  on  rates.  If  the  manufacturers 


COMPETITION  OF  COMPANIES 


63 


at  D  have  natural  advantages  over  those  at  B,  are 
nearer,  for  example,  to  the  market  and  to  a  source  of 
iron  ore,  the  line  serving  D  can  charge  considerably 
higher  rates  in  proportion  to  distance,  or  perhaps  rates 
absolutely  higher,  than  the  line  serving  B ,  and  still 
keep  the  manufacturing  industry  in  its  territory.  If, 
therefore,  a  railroad  has,  throughout  any  part  of  its 
territory,  no  competition  to  meet  but  the  competition 
of  locations,  it  is  pretty  certain  that  it  can  make  some 
of  its  rates  high,  even  rates  to  a  common  market,  with¬ 
out  corresponding  loss  of  traffic.  The  loss  would  fall 
upon  the  owners  of  favorably  situated  land.  Thus,  to 
take  another  example,  high  rates  on  wheat,  if  the  wheat 
is  produced  on  exceptionally  good  land,  or  high  rates 
compared  to  distance,  if  it  is  produced  near  a  market, 
will  simply  reduce  the  profits  of  agricultural  land  owners, 
but  will  not  cause  them  to  abandon  their  fields,  though 
they  may,  in  consequence,  cultivate  not  so  intensively. 

Competition  of  locations  has  existed  in  the  past, 
and  probably  in  some  degree  still  exists,  in  the  trans¬ 
portation  of  lumber  from  Minneapolis,  Milwaukee, 
Chicago,  Winona,  La  Crosse,  Eau  Claire,  and  other 
points  in  northern  Michigan  and  along  the  Mississippi 
River,  to  Missouri  River  points,  e.g.  Kansas  City, 
Omaha,  Sioux  City,  etc.,  as  consuming  centers.1  Many 
of  these  Missouri  River  cities  were  common  markets 
served  by  more  than  one  railroad.  Each  railroad 
desired  that  such  a  common  market  or  markets  should 
be  supplied  most  largely  from  lumber  production  along 
its  own  lines.  Rates  made  by  any  one  such  road,  un¬ 
duly  high  in  relation  to  rates  made  by  its  rivals  serv¬ 
ing  other  centers  of  lumber  production,  meant  that  the 

1  Interstate  Commerce  Commission  Reports,  Vol.  V,  pp.  264-298. 


64  TRANSPORTATION  COSTS  OF  COMMERCE 


production  of  lumber  on  its  line  would  decrease  or 
cease.  Producers  would  prefer  to  engage  in  the  busi¬ 
ness  at  a  point  where  rates  were  not  so  high.  Until 
an  agreement  was  reached  by  the  various  roads,  in  1884, 
fixing  the  relation  of  rates  to  be  charged  from  various 
lumber  centers,  there  was  a  considerable  amount  of 
keen  competition  among  the  railroads  concerned. 
Where  the  rates  of  different  transportation  companies 
are  so  adjusted,  each  to  each,  reduction  of  the  rates  of 
one,  by  order  of  a  government  regulating  commission, 
may  indirectly  force  reduction  of  the  rates  of  others. 

Where  the  competition  is  a  competition  of  directions 
or  a  competition  of  business  locations,  as  well  as  where 
it  is  a  competition  of  routes,  it  may  sometimes  be  not 
undesirable  that  some  goods  should  be  carried  over  a 
longer  instead  of  all  being  carried  over  a  shorter  route. 
For  the  longer  route  may  sometimes  have  enough  more 
intermediate  traffic  so  that  it  can  afford  to  take  the 
longer  distance  traffic  for  lower  rates  than  a  shorter 
route  can  afford.1 

§5 


Competition  against  Potential  Local  Self-sufficiency 

Besides  competing  with  each  other,  transportation 
companies  may  be  said  to  compete,  also,  in  a  sense, 
with  local  self-sufficiency.  Especially  when  distances 
are  great,  reasonably  low  rates  per  mile  are  necessary, 
in  order  that  different  districts  should  specialize  in  dif¬ 
ferent  lines  of  activity  and  exchange  their  various 
products  with  each  other.  High  transportation  rates 
compel,  in  each  district,  a  greater  degree  of  self-suffi¬ 
ciency.  Low  rates  promote  commerce.  To  some  extent, 

1  Cf.  §  2  of  this  Chapter  (II  of  Part  III). 


COMPETITION  OF  COMPANIES 


65 


transportation  companies  doubtless  bid  for  the  business 
of  transporting  goods  over  long  distances,  thus  taking 
part  in  the  competition  of  shippers  with  local  producers 
in  the  territory  to  which  the  goods  are  sent. 

To  illustrate,  suppose  two  sections  of  the  country, 
A  and  B,  1000  miles  apart  but  joined  by  the  railroad 
AB.  (See  figure  7.)  The  general  level  of  prosperity 

- — - - — XrB 

Figure  7 

in  other  industries  at  A  may  be  such  that  no  one  will 
mine  coal  there  (of  which  there  are  deposits)  for  less 
than  $3  a  ton.  In  j5,  on  the  other  hand,  conditions  are 
such  that  coal  cannot  be  produced  and  sold  locally  for 
less  than  $5  a  ton  and  yield  as  good  a  return  on  labor 
and  investment  as  other  local  industries.  Unless  the 
railroad  AB  makes  a  rate  of  $2  a  ton  or  less  for  carrying 
coal  1000  miles,  B  will  produce  its  own  coal,  A  will 
probably  engage  more  largely  in  the  production  of 
goods  for  local  use,  and  the  railroad  AB  will  not  get 
the  coal  traffic. 

Such  competition  with  local  self-sufficiency  has  been 
of  recent  importance  in  Indiana.  In  the  northern  part 
of  that  state,  many  wagon  roads  have  been  in  process 
of  construction.  In  the  building  of  these  roads,  there 
has  frequently  been  the  alternative  of  using  gravel  from 
gravel  pits  within  a  few  miles  of  the  roads  to  be  made, 
or  crushed  stone  from  various  quarries  near  Chicago, 
Toledo,  and  Milwaukee.  The  railroads  have  made  low 
rates  on  the  crushed  stone,1  in  order,  by  enabling  quarry 
owners  to  ship  their  product,  to  get  traffic  which  other¬ 
wise  could  not  have  been  had. 

1  McPherson,  Railroad  Freight  Rates,  p.  14a. 

PART  ra  —  p 


66  TRANSPORTATION  COSTS  OF  COMMERCE 


§6 

Two  Senses  of  “ What  the  Traffic  Will  Bear” 

The  classic  and  usual  statement  with  regard  to  rates 
independently  made  by  railroads,  i.e.  made  without  di¬ 
rection  or  interference  from  government,  is  that  these 
rates  are  made  on  the  basis  of  “what  the  traffic  will 
bear.”  1  This  statement,  properly  understood,  is  cor¬ 
rect,  but  its  meaning  requires  some  explanation.  To 
say  that  a  railroad  leading  from  the  Pennsylvania  coal 
fields  to  New  York  City  will  charge,  on  coal  shipped 
to  New  York,  what  the  traffic  will  bear,  does  not  mean 
that  if  higher  rates  are  charged,  the  railroad  will  not 
get  any  traffic  at  all.  Neither  does  it  mean  that  at 
lower  rates  the  railroad  would  not  get  more  traffic. 
It  means,  simply,  that  the  rates  charged,  when  there  is 
no  legal  regulation  and  when  the  interests  of  the  railroad 
are  chiefly  or  solely  considered,  will  always  be  the  rates 
yielding  the  largest  net  returns  on  capital  invested.2 
Higher  rates  will  so  decrease  traffic  that  even  the  larger 
return  per  unit  business  will  be  a  smaller  net  return  on 
capital.  Lower  rates  will  usually  increase  traffic,  but 
will  not  increase  it  enough  to  compensate  for  the  smaller 
return  per  unit  business  and  the  larger  expense  of  carry¬ 
ing  more  goods.  On  any  special  kind  or  class  of  traffic, 
therefore,  the  rates  charged  by  a  given  railroad  are 
those  yielding  it  the  greatest  profit ;  or,  in  this  sense  of 
the  expression,  the  rates  charged  are  what  the  traffic 
will  bear. 

But  though  monopolistic  as  well  as  competing  transpor- 

1  Hadley,  Railroad  Transportation,  New  York  (Putnam),  1885,  p.  hi. 

2  Far-sighted  management  may  of  course  consider  the  future  as  well  as  the 
present. 


COMPETITION  OF  COMPANIES 


67 


tation  companies  base  their  rates  on  what  the  traffic 
will  bear,  the  conditions  determining  monopolistic  rates 
are  markedly  different  from  those  fixing  competitive 
rates.  The  rates  which  monopolized  traffic  will  bear 
are  usually  higher  than  the  rates  which  competitive 
traffic  will  bear.  A  transportation  company  having  a 
monopoly  is  concerned  only  with  the  effect  of  its  rates 
on  the  total  volume  of  traffic  within  its  territory,  for 
its  own  traffic  is  synonymous  with  this  total  traffic. 
Its  only  fear  is  that  its  rates  may  be  so  high  as  to  de¬ 
stroy  transportation  business.  Such  a  company’s  rates 
need  only  be  what  the  traffic  will  bear  without  being  de¬ 
stroyed  in  whole  or  in  part. 

A  transportation  company  having  competitors,  how¬ 
ever,  is  interested  not  only  in  the  effect  its  rates  may 
have  on  the  total  transportation  business  of  the  territory 
it  serves,  but  also,  and  usually  to  a  much  greater  extent, 
in  the  effect  its  rates  may  have  on  its  own  business  com¬ 
pared  with  that  of  its  rivals.  A  slight  change  in  its 
rates  will  probably  make  very  little  difference  in  the 
total  amount  of  goods  carried  in  the  given  territory, 
even  if  its  rivals  make  exactly  similar  changes.  But  a 
slight  change  in  its  rates,  if  its  rivals  do  not  make  similar 
changes,  will  probably  affect  very  greatly  the  amount 
of  business  done  by  the  particular  company  making 
the  change.  A  slightly  higher  rate  will  result  in  divert¬ 
ing  much  or  most  of  its  business  to  its  rivals.  A  slightly 
lower  rate  will  result  in  its  getting  business  away  from 
them.  We  may  say,  therefore,  that  the  rates  charged 
by  a  transportation  company  subject  to  competition 
will  be  what  the  traffic  will  bear  without  being  diverted. 

What  the  traffic  will  bear  without  being  destroyed, 
is  generally  more  than  what  the  traffic  will  bear  without 


68  TRANSPORTATION  COSTS  OF  COMMERCE 


being  diverted.  Therefore,  monopoly  rates  are  gener* 
ally  higher  in  proportion  to  distance  or  to  service  ren¬ 
dered,  than  competitive  rates.1  It  is  commonly  deemed 
essential  to  regulate  monopoly  rates  by  government 
for  the  protection  of  the  general  public  and  for  the 
furtherance  of  commerce.  Unregulated  monopoly  rates, 
though  they  will  not  be  made,  with  intention,  so  high 
as  to  decrease  net  profits,  may,  nevertheless,  be  made 
so  high  that  the  volume  of  commerce  becomes  smaller 
than,  for  the  greatest  national  wealth,  it  ought  to  be. 
A  monopolistic  transportation  company  can  well  afford 
to  charge  rates,  for  carrying  a  given  kind  of  goods 
between  two  points,  20  per  cent,  above  a  competitive 
level,  if  its  doing  so  makes  its  traffic  less  than  it  other¬ 
wise  would  be  by  only  10  per  cent.  Yet  the  monopoly 
rates,  in  thus  making  traffic  less,  even  by  but  10  per 
cent.,  would  be  preventing  commerce  which  ought,  for 
the  general  welfare,  to  take  place. 

§  7 

Summary 

Competition  of  transportation  companies  with  each 
other  we  have  seen  to  be  of  four  kinds :  competition  of 
different  companies  over  the  same  route,  competition 
of  routes,  competition  of  directions,  and  competition  of 
locations.  In  addition,  a  transportation  company  may 
be  said  to  compete,  in  a  sense,  with  potential  local  self- 
sufficiency.  Competition  of  different  companies  over  the 
same  route  applies  particularly  to  competition  on  open 


1  Cf.  Carver,  The  Distribution  of  Wealth,  New  York  (Macmillan),  1904,  p.  48. 
See  also  article  by  the  present  writer  in  the  Quarterly  Journal  of  Economics, 
August,  1908,  entitled  Competitive  and  Monopolistic  Price  Making. 


COMPETITION  OF  COMPANIES 


69 


waterways.  In  the  case  of  railroads,  the  right  of  way 
of  one  company  is  generally  used  only  by  that  company. 
Competition  of  routes  applies  both  to  railways  and  to 
waterways.  The  other  kinds  of  competition  are  of 
more  importance  in  relation  to  railways,  though  not  in¬ 
conceivable  in  the  case  of  water  transportation. 

When  two  or  more  routes  join  two  given  points,  the 
usual  rule  is  that  transportation  over  the  shortest  or 
the  most  level  route  is  the  most  economical,  although  it 
does  not  necessarily  follow  that  the  beneficial  stimulus 
of  competition  and  its  protection  of  the  public  against 
monopoly  should  be  sacrificed  to  enforce  the  carriage 
of  goods  by  the  shortest  available  line.  On  the  other 
hand,  there  are  cases  where  a  longer  line  is  a  more  eco¬ 
nomical  one  for  the  carriage  of  goods  between  two 
given  points,  than  a  shorter  one.  In  the  first  place, 
the  traffic  may  be  in  excess  of  the  carrying  capacity  of 
the  more  direct  line,  and  it  may  be  better  to  use  the 
longer  line,  even  though  the  profit  is  small,  than  to  in¬ 
vest  additional  capital  in  railroad  plant.  In  the  second 
place,  it  may  be  preferable  to  build  a  roundabout  rather 
than  a  direct  line  (or  than  more  tracks  on  a  direct  line 
already  built)  to  carry  traffic  unprovided  for  between 
two  points  if  the  roundabout  line  taps  enough  more 
intermediate  traffic  than  the  direct  line  (or  than  the 
new  trackage  on  the  direct  line  could  add),  so  that  the 
longer  distance  traffic,  having  to  pay  less  of  the  general 
expenses  and  profits,  can  be  carried  by  the  roundabout 
line  more  cheaply.  In  the  third  place,  if  facilities  be¬ 
tween  two  points  are  in  excess  of  traffic,  and  one  line 
has  to  be  abandoned,  it  may  be  preferable  to  abandon 
a  shorter  line  rather  than  a  longer,  provided  the  longer 
line  has  much  more  of  intermediate  traffic  which  helps 


70  TRANSPORTATION  COSTS  OF  COMMERCE 


it  to  be  profitable  and  enables  it  to  carry  goods  between 
the  two  given  points  for  a  relatively  low  rate. 

Competition  of  directions  exists  when  each  of  two 
(or  more)  lines  is  compelled  to  make  rates  from  a  given 
center  of  production,  based  on  the  rates  made  by  a 
rival  leading  in  a  different  direction  and  to  a  different 
market.  That  this  competition  may  be  effective,  there 
must  be  other  conditions  —  in  our  illustrations  other 
transportation  lines  —  influencing  prices  in  both  mar¬ 
kets  or  in  the  source  of  production  and  at  least  one  of 
the  markets. 

Competition  of  locations  exists  when  transportation 
lines  endeavor  to  make  conditions  favorable  for  various 
industries,  in  territories  which  they  serve,  by  reasonable 
rates  on  raw  materials,  finished  products,  etc.,  in  order 
that  the  industries  may  develop  along  their  lines  instead 
of  elsewhere.  These  last  two  kinds  of  competition  have 
doubtless  some  importance,  but  are  less  effective  than 
the  first  and  second  kinds. 

Monopoly  rates  are  usually  higher  than  competitive 
rates,  because  the  former  are  based  on  what  traffic  will 
bear  without  being  destroyed,  while  the  latter  are  based 
on  what  traffic  will  bear  without  being  diverted;  and 
because  a  rise  in  a  transportation  company’s  rates 
which  would  have  almost  no  effect  in  decreasing  the 
total  amount  of  traffic  would,  if  the  company  has 
competitors,  cause  most  of  its  business  to  be  diverted 
to  them.  Unregulated  monopoly  rates  may  prevent 
commerce  which  is  economically  desirable. 


CHAPTER  III 


Transportation  Monopoly 

§  i 


Monopoly  of  Rail  Transportation 

Railroads  are  usually,  if  not  always,  partial  mo¬ 
nopolies.  However  much  the  kinds  of  competition  we 
have  described  may  affect  rates  on  traffic  to  and  from 
large  competitive  centers,  there  is  on  nearly  every  rail¬ 
road  intermediate  traffic  not  correspondingly  subject  to 
competitive  influence. 

Even  as  to  traffic  between  competitive  points,  compe¬ 
tition  has  often  been  checked  by  some  form  of  rate  agree¬ 
ment  among  the  rival  railroad  companies.  Experience 
early  showed  that  there  was  sometimes  great  temptation 
for  one  or  more  of  the  companies  to  depart  from  the 
agreed  rates,  not  unusually  by  secret  arrangement  with 
a  favored  shipper  or  shippers,  in  order  to  get  greater 
traffic  at  the  expense  of  the  other  parties  to  the  agree¬ 
ment.  Hence  various  pooling  devices  were  adopted. 
These  pooling  devices  involved  1  either  a  division  of  the 
business  in  some  definite  proportions  among  the  roads 
concerned,  or  a  division  of  the  earnings  from  the  business. 
When  the  latter  plan  was  determined  upon,  each  road 
was  entitled  to  carry  all  the  freight  it  could  get,  but  must 

1  See  Hadley,  Railroad  Transportation,  New  York  (Putnam),  1885,  p.  74; 
or  Johnson,  American  Railway  Transportation,  2d  revised  edition,  New  York 
(Appleton),  1909,  pp.  224,  225. 


7i 


72  TRANSPORTATION  COSTS  OF  COMMERCE 


divide  any  surplus  profits  so  made,  with  the  other  parties 
to  the  pool.  To  enforce  this  provision  it  was  frequently 
required  of  each  company  that  it  keep  a  considerable 
sum  on  deposit  in  a  common  treasury,  this  sum  to  be 
forfeited  in  case  of  violation  of  agreement.1 2 

The  Interstate  Commerce  Act  of  1887  made  pooling 
by  railroads  illegal,  and  the  kinds  of  arrangement  above 
described  had  to  be  dropped.  For  a  time  the  railroads 
of  the  United  States  attempted  to  make  and  enforce 
rate  agreements  by  means  of  their  traffic  associations, 
even  though  pooling  was  forbidden.  The  Joint  Traffic 
Association  of  1896  made  departure  from  its  recom¬ 
mended  rates  punishable  by  fines.  But  in  the  mean¬ 
while  the  Sherman  Anti-trust  Act  had  been  passed  in 
1890,  and  this  act  was  so  interpreted  by  the  Supreme 
Court  in  the  Trans-Missouri  Freight  Association  case 
(1897) 2  and  in  the  Joint  Traffic  Association  case  (1898) 3 
as  to  forbid  any  agreement  for  the  maintenance  of  rates. 
The  same  law  was  interpreted  by  the  Supreme  Court 
in  the  Northern  Securities  case,4  in  1904,  to  forbid  the 
holding  of  the  stock  of  two  potentially  competing  roads 
by  a  holding  company.  And  in  1912  this  tribunal,  in  a 
case  involving  the  possession  of  stock  by  the  Union 
Pacific  in  the  Southern  Pacific  Railroad,5  decided  that 
it  was  illegal  for  any  railroad  company  to  hold  a  control¬ 
ling  interest  (even  less  than  a  majority  of  stock,  if 
substantial  control  was  thus  secured)  in  what  might 
otherwise  be  a  competing  railroad.  By  the  terms  of  the 
new  Clayton  Act,6  interholding  of  stock  and  the  holding 
of  stock  by  so-called  “holding”  companies  is  prohibited, 


1  Johnson,  American  Railway  Transportation,  p.  240. 

2 166  U.  S.,  290.  3 171  U.  S.,  s°5» 

1  226  U.  S.,  61.  6  October,  1914. 


4 193  U.  S.,  197. 


TRANSPORTATION  MONOPOLY 


73 


where  the  effect  may  be  a  substantial  lessening  of  com¬ 
petition.  But  it  is  doubtful  whether  this  prohibition 
really  adds  much  to  the  Anti-trust  Law  of  1890  as  that 
law  has  been  interpreted  by  the  Supreme  Court.  Repre¬ 
sentatives  of  different  systems  of  course  meet  in  the 
conferences  of  the  various  traffic  associations  to  discuss 
traffic  conditions,  and  these  meetings  bring  about 
informal  understandings  regarding  rates.1  But  any 
formal  agreement  to  maintain  rates  is  illegal. 

It  can  hardly  be  said  that  complete  monopoly  is  in¬ 
evitable  in  railway  transportation,  on  the  ground  that 
competition  is  necessarily  ruinous.  Competition  is  not 
necessarily  ruinous.  To  begin  with,  as  we  have  already 
seen,  there  is  on  almost  every  railroad  intermediate 
traffic  for  which  there  is  no  competition.  Furthermore, 
even  if  all  traffic  were  strictly  competitive,  competition 
would  not  be  likely  to  reduce  average  profits  below  a 
fair  return  on  capital,  unless  transportation  facilities 
were  in  excess  of  traffic  requirements.  When  the 
traffic  available  at  reasonable  rates  taxes  the  plants  of 
all  the  railroads  between  any  two  points,  no  one  of  the 
roads  needs  to  reduce  its  rates  to  an  unprofitable  level 
even  if  its  rivals  choose  to  reduce  theirs.  For,  by 
hypothesis,  its  rivals  cannot  carry  all  the.  traffic,  and 
there  will  still  be  business  for  the  non-reducing  road. 
Nor  can  we  assume  that  the  reducing  companies  will 
care  to  enlarge  their  plants  so  as  to  carry  larger  traffic, 
unless  the  rates  which  can  be  charged  are  profitable. 
When  additions  to  plant  are  made,  at  least  if  they 
are  made  by  companies  already  in  the  field  rather  than 
by  the  building  of  rival  roads,  these  additions  may  be 
gradual  and  not  greater  than  gradually  increasing 

Johnson,  American  Railway  Transportation ,  p.  248. 


74  TRANSPORTATION  COSTS  OF  COMMERCE 

business  requires.  Additional  and  larger  cars,  additional 
switches  to  permit  more  frequent  train  service,  perhaps 
an  additional  track  where  traffic  is  most  dense,  will  not 
of  necessity  so  alter  the  relation  between  facilities  and 
requirements  as  to  bring  about  cutthroat  competition. 

If,  however,  a  new  railroad  is  constructed  when  exist¬ 
ing  roads  are  adequate,  or  if  temporary  decline  of  busi¬ 
ness,  as  during  an  industrial  depression  or  during  a  dull 
season,  makes  facilities,  for  the  time  being,  in  excess  of 
traffic  needs,  unchecked  competition  may  reduce  rates 
below  a  profitable  level.  Each  road  will  take  traffic 
which  yields  little  towards  general  expenses  and  fixed 
charges,  rather  than  not  get  such  traffic.  Hoping  to 
secure  at  the  expense  of  their  rivals,  by  charging  very  low 
rates,  the  large  amount  of  traffic  necessary  to  make 
such  rates  cover  general  and  other  expenses,  the  man¬ 
agers  of  each  road  may  succeed  only  in  reducing  their 
road  to  bankruptcy.1  For  if  every  other  road  concerned 
reduces  rates  in  the  same  degree,  the  reductions  by  the 
one  road  will  not  probably  much  increase  its  business 
so  as  to  make  the  low  rates  profitable.  Nevertheless, 
the  excessive  rate  reductions  result,  in  large  part,  from 
the  existence  of  more  transportation  facilities  than  can 
be.  fully  utilized.  They  are  not  the  invariable  and  in¬ 
evitable  consequences  of  all  railroad  competition. 

It  has  often  been  argued  that  such  cutthroat  com¬ 
petition,  and  the  discrimination  in  favor  of  competitive 
traffic  to  which  it  leads,  can  be  most  effectively  pre¬ 
vented  by  removing  the  prohibition  against  rate  agree¬ 
ments,  even,  perhaps,  making  them  legally  enforcible, 
and  by  giving  legal  recognition  to  pooling.2  Such  a 

1  Cf.  Hadley,  Railroad  Transportation ,  pp.  70-74. 

*  Cf.  Chapter  IV  (of  Part  III),  §  2. 


TRANSPORTATION  MONOPOLY 


75 


change  in  governmental  policy  might  not  be  unwise 
—  would,  in  fact,  be  highly  desirable  —  if  all  permitted 
agreements  were  required  to  receive  the  sanction  of  the 
Interstate  Commerce  Commission.  But  it  must  be 
remembered,  first,  that  the  era  of  speculative  railroad 
building  in  the  United  States  has  probably  passed ;  and 
second,  that  the  Elkins  Law  (of  1903),  by  prohibiting 
departures  from  published  rates,  and  the  Interstate 
Commerce  Law  (as  revised  in  1906),  by  insisting  that 
no  rate  changes  shall  be  made  without  30  days’  notice, 
have  operated  to  prevent  the  old-time  competition  with 
its  accompaniment  of  demoralized  rates.  Hence,  the 
importance  of  permitting  agreements  is  less  than 
formerly,  though  there  are  probably,  still,  occasions 
when  recognized  agreements  would  be  beneficial. 

So  far  as  there  is  monopoly  of  rail  transportation, 
from  any  cause,  the  American  public  and  its  trade  inter¬ 
ests  are  protected  by  the  rate-regulating  power  of  the 
Interstate  Commerce  Commission  and  the  various  state 
commissions.  By  the  amendments  of  1906  and  1910  to 
the  Interstate  Commerce  Law,  the  Interstate  Commerce 
Commission  was  given  the  power  to  fix  maximum  charges 
for  any  (interstate)  traffic  after  investigation,  and  to 
suspend  proposed  rate  advances  for  a  total  period  not 
to  exceed  10  months,1  pending  examination  as  to  the 
justification  of  such  advances. 

§  ^ 

Agreements  between  Navigation  Companies 

Transportation  on  natural  waterways,  particularly 
on  the  ocean,  is,  it  would  appear,  less  likely  to  be  con- 

1  More  precisely  1 20  days  plus,  if  necessary,  a  further  period  of  6  months. 


76  TRANSPORTATION  COSTS  OF  COMMERCE 


trolled  by  monopoly,  is  more  subject  at  all  terminals 
(or  ports)  to  competition,  than  is  transportation  by  rail. 
The  principal  reason  for  this  difference  is  the  fact  that 
the  way  or  route  costs  nothing  and  is  open  to  all  com¬ 
panies  on  equal  terms,  while,  in  the  case  of  railways, 
the  way  or  route  is  expensive  and  can  be  used  only  by  the 
company  which  owns  it.  Railway  traffic  between  two 
points  is  often  subject  to  monopoly  control  because 
there  is,  between  those  points,  only  traffic  enough  to 
justify  a  single  line.  Another  company,  choosing  to 
compete  for  this  traffic,  would  have  to  construct  an  en¬ 
tire  new  roadway  between  the  points  in  question.  The 
investment  of  the  second  company  might  have  to  be  as 
great  as  that  of  the  first,  in  order  for  it  to  compete  at  all. 
Its  investment  would  almost  certainly  be  a  considerable 
fraction  of  that  of  the  first.  So  large  an  addition  to  the 
total  railway  plant  connecting  two  places  would  be  likely 
to  mean  no  adequate  return  on  the  new  capital,  and  it 
might  mean,  since  general  expenses  run  on  even  when 
traffic  is  small,  no  return  whatever.  Under  these  cir¬ 
cumstances  a  new  line  would  seldom  be  constructed. 
There  would  be  no  competition.  There  would  only  be 
one  route  or  way.  One  company  would  own  it  and  no 
other  could  use  it.  The  owning  company  would  have 
the  situation  entirely  in  its  own  hands  and  could  charge 
what  it  desired,  subject  only  to  legal  limitations  and  the 
less  direct  kinds  of  competition.1 

In  the  case  of  water  transportation,  however,  the 
situation  is  different.  In  order  for  a  competition  to  be 
started  against  a  company  already  engaged  in  carrying 
goods  between  two  points,  it  is  not  necessary  that 
another  company  shall  be  found,  willing  and  able  to 

1  See  previous  Chapter  (II  of  Part  III),  §§  3,  4,  5. 


TRANSPORTATION  MONOPOLY 


77 


provide  capital  enough  for  the  construction  of  perhaps 
hundreds  of  miles  of  roadbed  and  track,  or  willing  and 
able  to  duplicate  or  nearly  duplicate  the  plant  of  its 
already  present  rival.  Though  the  earlier  company  may 
have  a  fleet  of  a  hundred  vessels,  yet  if  the  new  company 
can  build  one  or  two  vessels,  it  is  at  once  in  a  position  to 
compete  for  whatever  part  of  the  trade  it  can  handle. 
In  a  sense,  a  new  company  can  compete  by  building  for 
this  particular  trade  a  fraction  of  a  vessel,  that  is,  it 
can  build  a  vessel  to  engage  partly  in  other  trade  and 
partly  in  this  particular  competitive  trade.  A  tramp 
vessel,  going  into  all  oceans,  now  here  and  now  there, 
and  seeking  traffic  in  cargo  lots,  may  be  built  and  turned, 
in  part,  to  the  trade  previously  monopolized.  When¬ 
ever  the  rates  of  the  regular-line  steamers,  those  sailing 
on  schedule,  exceed  the  charter  rate  for  tramp  steamers, 
large  shippers  are  likely  to  patronize  the  tramp  vessels.1 
Even  small  shippers,  who  cannot  alone  accumulate 
sufficient  cargoes  to  justify  the  chartering  of  vessels,  are 
enabled  to  utilize  tramp  vessels  through  the  intermedia¬ 
tion  of  charter  brokers  who  accumulate  the  cargoes  of 
numbers  of  merchants  and  who  charter  vessels  to  carry 
these  cargoes.2 

Nevertheless,  traffic  agreements  and  other  devices  to 
maintain  monopoly  or  partial  monopoly  are  common, 
and  appear  to  be  not  altogether  ineffective,  in  water 
transportation.  “  Practically  all  the  well-known  lines 
connecting  North  Atlantic  American  ports  with  those  of 
the  United  Kingdom,  North  Europe,  and  the  Mediter- 

1  Huebner,  Report  on  Steamship  Agreements  and  Affiliations  in  the  American 
Foreign  and  Domestic  Trade,  in  Proceedings  of  the  Committee  on  the  Merchant 
Marine  and  Fisheries  in  the  Investigation  of  Shipping  Combinations,  Vol.  IV, 
19x4,  p.  299. 

'Ibid. 


78  TRANSPORTATION  COSTS  OF  COMMERCE 


ranean,  have  been  parties  to  numerous  freight  agreements 
covering,  in  one  way  or  another,  nearly  every  sphere  of 
the  American-European  trade.  ”  1  It  appears  that  “  over 
40  regular  trans- Atlantic  lines  have  been  parties  in  their 
respective  trades  to  at  least  20  agreements  involving  the 
freight  traffic,  and  that  the  important  lines  have  been 
members  of  at  least  four  main  freight  conferences.” 2 

In  some  instances  the  traffic  is  indirectly  apportioned 
by  an  allotment  of  the  ports  of  sailing.  Thus,  the  Ham¬ 
burg- American  and  the  North  German  Lloyd  companies 
have  had  an  agreement  by  which  Hamburg  is  reserved 
for  the  former  and  Bremen  for  the  latter  as  regards  sail¬ 
ings  from  all  American  ports  north  of  Savannah.3  In 
the  American-Asiatic  trade  not  only  have  there  been 
agreements  as  to  rates  both  eastward  and  westward, 
but  there  have  also  been  arrangements  to  the  effect  that 
the  net  freights  earned  should  be  pooled.4  Sometimes, 
also,  there  has  been  an  agreed  limit  to  the  number  of 
sailings  to  be  made  by  each  of  several  lines,  and  occasion¬ 
ally  there  has  been  a  limitation  placed  upon  the  amount 
of  freight  which  some  line  or  lines  may  carry.5 

Control  of  transportation  by  so-called  conference 
lines  is  furthered  by  the  deferred  rebate  system.  Under 
this  system  it  is  arranged  that  shippers  who  agree  to  use 
only  the  vessels  of  the  conference  lines  in  a  given  trade  or 

1  Huebner,  Report  on  Steamship  Agreements  and  Affiliations  nn  the  American 
Foreign  and  Domestic  Trade,  in  Proceedings  of  the  Committee  on  the  Merchant 
Marine  and  Fisheries  in  the  Investigation  of  Shipping  Combinations,  Vol.  IV, 
I9I4>  P-  59-  This  report,  referred  to  here  and  in  the  following  pages,  was  made  just 
before  the  outbreak  of  the  present  war,  which  has,  as  is  well  known,  tended  to 
disorganize  conditions  of  ocean  commerce,  but  not,  of  course,  by  rate  reductions. 
Agreements  are  not  now  necessary  even  to  keep  rates  far  above  their  normal 
level.  Some  lines  which  were  parties  to  agreements  are  not,  at  present,  carry¬ 
ing  on  business. 

2  Ibid. 

4  Ibid.,  p.  1 1 7. 


3  Ibid.,  p.  71. 

6  Ibid.,  p.  285. 


TRANSPORTATION  MONOPOLY 


79 


trades,  shall  receive  a  rebate  of  some  5  or  10  per  cent,  on 
their  freight  bills,  which  rebate  is  payable  to  them  per¬ 
haps  six  months  after  the  end  of  the  period  for  which  it 
is  computed.  Any  shipper  who,  at  any  time  before  the 
period  of  deferment  has  expired,  ships  goods  by  other 
than  the  conference  lines,  loses  the  benefit  of  the  rebate.1 
The  deferred  rebate  system  is  applied,  for  example,  in 
the  westbound  trade  from  the  Far  East  through  the 
Suez  canal  to  the  United  States 2  and  in  the  trade  between 
the  United  States  and  South  America.3 

It  is  sometimes  claimed  that  this  system  is  advanta¬ 
geous  to  shippers,  on  the  ground  that,  by  guaranteeing 
large  and  regular  business  to  the  favored  navigation 
companies,  it  enables  them  to  give  efficient,  regular,  and 
frequent  service.4  But  that  the  system  is  unnecessary 
as  a  means  of  securing  good  and  regular  service  seems  to 
be  indicated  by  the  fact  that  many  conferences  do  not 
employ  it.5  And  it  is  obvious  that  such  a  system  may 
be,  as  it  in  fact  has  been,  so  used  as  to  make  effective 
competition  by  outside  lines  very  difficult  and  at  times 
impossible,  and  thus  to  make  shippers  absolutely  depend¬ 
ent  upon  the  conference  lines.6  For  these  lines,  having 
generally  a  considerable  number  of  vessels  among  them, 
can  so  arrange  the  order  of  sailings  for  the  different  lines 
as  to  give  a  frequent  service.  An  independent  line, 
endeavoring  to  compete  with  the  others,  cannot  usually 
give,  alone,  an  equally  frequent  service.  Many  shippers 
will  therefore  find  themselves  compelled  to  patronize 
one  or  more  of  the  conference  lines  a  part  of  the  time  7 
even  though  the  conference  rates  are  higher,  and  may 

1  Ibid.,  p.  287.  2  Ibid.,  p.  118. 

3  Ibid.,  p.  161.  4  Ibid.,  pp.  161,  162. 

6  Ibid.,  p.  307.  8  Ibid.,  pp.  163-165. 

7  Ibid.,  p.  165. 


So  TRANSPORTATION  COSTS  OF  COMMERCE 


conclude  to  patronize  these  lines  all  the  time  and  so 
receive  the  deferred  rebates.  Shippers  may  also  fear 
that  if  they  patronize  a  competing  line  which  cannot 
alone  give  them  all  the  sailings  required,  the  other  lines, 
on  which  they  are  in  part  dependent,  will  refuse  abso¬ 
lutely  to  carry  any  of  their  goods.  An  illustration  is 
afforded  by  the  experience  of  the  Lloyd  Braziliero  line, 
an  independent  line  operating  between  Brazil  and  the 
United  States.  This  line,  though  charging  rates  of  from 
26  to  32  cents  per  bag  on  coffee  as  compared  to  conference 
rates  of  45  to  50  cents,  was  able  to  carry  the  coffee  of  but 
one  important  shipper  and  only  a  part  of  that.1  This 
company,  Arbuckle  Bros.,  was  refused  the  service  of  the 
conference  lines  and  has  had  to  charter  vessels  for  a  large 
part  of  its  shipments.2  It  now  appears,  however,  that 
such  refusal  to  serve  shippers  may  constitute  restraint  of 
trade  and  be  illegal.3 

It  can  hardly  be  said  that  business  obtained  by  navi¬ 
gation  companies  in  this  way  is  fairly  earned.  Business 
so  obtained  is  not  the  reward  of  superior  efficiency 
shown  in  better  service  or  lower  rates.  It  is  rather  the 
result  of  combined  efforts  to  shut  out  possible  competi¬ 
tion  ;  it  is  the  result  of  what  is,  in  effect,  a  conspiracy 
against  freedom  of  commerce  and  against  the  general 
well-being. 

Another  method  of  preventing  long-continued  compe¬ 
tition  is  by  the  use  of  so-called  fighting  ships,  i.e.  by 

1Huebner,  Report  on  Steamship  Agreements  and  Affiliations  in  the  American 
Foreign  and  Domestic  Trade,  in  Proceedings  of  the  Committee  on  the  Merchant 
Marine  and  Fisheries  in  the  Investigation  of  Shipping  Combinations,  Vol.  IV, 
1914,  pp.  165,  166. 

2  Ibid.,  p.  167. 

3  See  United  States  v.  Prince  Line,  Limited,  et  al.,  220  Fed.  Rep.,  230,  in  which 
the  court  granted  an  injunction  against  refusal  to  carry  for  any  shipper  at  regular 
rates. 


TRANSPORTATION  MONOPOLY 


81 


collective  competition  against  a  single  outside  line.  The 
conference  lines  buy  or  set  aside  certain  ships  for  this 
purpose.  These  vessels  underbid  the  rates  of  the  out¬ 
side  line  even  though  to  do  so  they  must  carry  at  a  loss, 
and  this  loss  is  borne  jointly  by  all  the  conference  lines.1 
The  would-be  competitor,  however  efficient  its  service 
and  however  low  its  rates,  may  thus  be  driven  out  of  the 
trade.  The  conference  lines  maintain  their  monopoly, 
not  by  superior  service  but  by  making  rival  service 
impossible. 

The  assumption  has  been  frequently  made,  in  the  past, 
that  water  transportation  is  naturally  competitive  and 
so  needs  little  or  no  regulation.  There  has  been,  until 
recently,  comparatively  little  attempt  to  investigate 
combinations  and  agreements  among  water  carriers,  or 
to  interfere  with  them  by  means  of  prosecutions  under 
the  Anti-trust  Law.  Nevertheless,  it  would  appear 
that  the  Anti-trust  Law  applies  to  such  combinations 
and  agreements  no  less  than  to  similar  arrangements 
between  railroads.  A  combination  of  shipowners, 
which  fixes  rates  of  transportation,  and  which  discrim¬ 
inates  against  shippers  using  other  lines,  so  maintaining 
or  endeavoring  to  maintain  a  monopoly,  has  been 
declared  to  be  illegal.2  A  combination  or  agreement  of 
water  carriers  for  the  control  of  transportation  to  and 
from  the  United  States  is  unlawful  and  void  regardless 
of  where  it  is  made  or  where  it  is  to  be  performed  or  by 
what  vessels  it  is  to  be  carried  out.3  Furthermore,  the 

1  Ibid.,  p.  46  and  pp.  289,  290. 

*  Thomsen  et  al.  v.  Union  Castle  Mail  S.  S.  Co.  et  al.,  92  C.  C.  A.,  315. 

3  United  Slates  v.  Hamburg-Amerikanische  Packet-Fahrt-Actien-Gesellschaft 
et  al.,  200  Fed.  Rep.,  806. 

The  Federal  government  recently  brought  suit,  under  the  Sherman  Law, 
against  the  steamship  lines  of  the  North  Atlantic  Conference.  The  government 
alleged  that  there  was  unlawful  combination  for  the  purpose  of  apportioning 
PART  ill  —  G 


82  TRANSPORTATION  COSTS  OF  COMMERCE 


Interstate  Commerce  Law  applies  not  only  to  railroad 
rates  but  also  to  rates  charged  for  transportation  “partly 
by  railroad  and  partly  by  water  when  both  are  used  under 
a  common  control,  management,  or  arrangement  for  a 
continuous  carriage  or  shipment,”  though  this  juris¬ 
diction  does  not  extend  to  lines  operating  between  the 
United  States  and  a  non-adjacent  foreign  country,  and 
the  Interstate  Commerce  Commission  is  empowered, 
by  the  amendment  of  1910,  to  establish  through  routes, 
joint  classifications,  and  joint  rates  and  to  prescribe  the 
division  of  such  rates  among  connecting  carriers,  not  only 

traffic  and  fixing  rates  and  that  there  was  a  use  of  “fighting  ships”  for  breaking 
down  competition.  An  injunction  was  asked  for,  prohibiting  the  entrance  or 
clearance  at  any  American  port,  of  any  ship  belonging  to  any  line  in  the  confer¬ 
ence.  The  court  granted  an  injunction  against  the  use  of  “fighting  ships”  but 
refused  to  regard  the  conference  arrangements  as  otherwise  illegal,  contending 
that  the  combination  was  a  necessary  means  of  preventing  cutthroat  competi¬ 
tion  ending  in  monopoly  of  the  strongest  or  in  complete  consolidation,  and  that, 
therefore,  the  combination  did  not  unreasonably  interfere  with  trade.  See 
United  States  v.  Hamburg- A  meric  an  S.  S.  Line  et  al.,  216  Fed.  Rep.,  971. 
This  decision  was  unsatisfactory  to  the  government,  and  the  case  was  immedi¬ 
ately  appealed  to  the  Supreme  Court.  See  New  York  World,  Oct.  14,  1914. 
The  comment  may  perhaps  be  fairly  made,  on  this  decision  of  a  district  court, 
that  to  permit  rate  agreements,  in  part  because  of  the  fear  of  complete  consoli¬ 
dation,  implies  the  belief  that  complete  consolidation  cannot  itself  be  prevented. 
In  any  case,  if  rate  agreements  of  some  kind  are  believed  to  be  reasonable  and 
a  necessary  means  of  avoiding  cutthroat  competition,  it  may  plausibly  be 
contended  that  the  agreed  rates  should  be  subject  to  the  supervision  of  a  govern¬ 
ment  regulating  body. 

A  more  recent  decision  of  the  same  district  court  dismisses  the  government’s 
Sherman  Anti-trust  Act  suit  against  the  Prince  line  and  others  comprising  the 
so-called  Brazilian  Steamship  Conference,  and  against  lines  comprising  the  Far 
Eastern  Steamship  Conference.  (See  220  Fed.  Rep.,  230.)  Curiously  enough, 
the  court  found  nothing  inconsistent  with  law  either  in  the  rate  agreements  made 
or  in  the  use  of  deferred  rebates.  It  is  difficult  to  believe  that  the  Supreme  Court 
will  take  a  like  position.  Its  interpretation  of  the  Sherman  law  “with  reason” 
seems  never  to  have  led  it  so  far  as  this  in  the  defense  of  monopoly.  On  the  con¬ 
trary,  it  has  shown  itself,  by  a  long  line  of  decisions,  hostile  to  combinations 
having  monopoly  power.  It  should  be  said,  however,  that  the  district  court 
granted  an  injunction  against  refusal  to  serve  any  shipper  at  the  regular  rates, 
and  intimated  that  an  injunction  would  have  been  granted  against  the  use  of 
“fighting  ships,”  had  evidence  of  such  use  been  presented. 


TRANSPORTATION  MONOPOLY 


83 


when  all  are  rail  carriers  but  also  when  one  is  a  carrier  by 
water,  provided  that  such  through  routes,  joint  classifi¬ 
cations,  and  joint  rates  have  not  been  voluntarily  estab¬ 
lished.  Finally,  the  Panama  Canal  Act  of  1912 
authorizes  the  Interstate  Commerce  Commission  to 
establish  physical  connection  between  rail  and  water 
lines,  when  reasonably  practicable  and  justifiable,  by 
directing  either  line  or  both  to  construct  necessary 
tracks ;  “to  establish  through  routes  and  maximum  joint 
rates  over  such  rail  and  water  lines,  and  to  determine  all 
the  terms  and  conditions  under  which  such  lines  shall  be 
operated  in  the  handling  of  the  traffic  embraced” ;  and 
“to  establish  maximum  proportional  rates  by  rail  to  and 
from  the  ports  to  which  the  traffic  is  brought,  or  from 
which  it  is  taken  by  the  water  carrier,  and  to  determine  to 
what  traffic  and  in  connection  with  what  vessels  and  upon 
what  terms  and  conditions  such  rates  will  apply.”  There 
is,  however,  no  law  regulating  either  the  rates  charged 
or  the  competitive  practices  followed  when  the  trans¬ 
portation  is  wholly  by  water.  Specific  prohibition  of 
the  use  of  “fighting  ships”  and  of  deferred  rebates,  and 
prohibition  of  any  unreasonable  discrimination  would 
be  desirable.1  Effective  regulation  would  probably 
involve,  also,  an  extension  of  the  jurisdiction  of  the  Inter¬ 
state  Commerce  Commission  to  include  transportation 
wholly  by  water. 

§  3 

Other  Causes  of  Monopoly  in  Water  Transportation 

Monopoly  control  of  commerce  has  also  been  furthered 
by  “  exclusive”  and,  though  to  a  less  extent,  by  “prefer- 

1  Cf.  Huebner,  Report  on  Steamship  Agreements  and  Affiliations  in  the  American 
Foreign  and  Domestic  Trade,  Vol.  IV,  p.  421. 


84  TRANSPORTATION  COSTS  OF  COMMERCE 

ential  agreements  between  railway  and  steamship 
companies.  These  agreements  provide  that  the  railroad 
company  and  the  steamship  line  involved  shall  each 
furnish  freight  to  the  other  and  that,  so  far  as  possible, 
all  through  freight  from  either  line  shall  be  delivered  to 
the  other  line  for  carriage  to  destination.1  Formerly, 
many  of  the  railroads  made  contracts  with  steamship 
lines,  which  bound  the  railroads  to  ship  goods  to  certain 
ports,  on  through  bills  of  lading,  only  by  the  steamship 
lines  with  which  the  contracts  were  made,  regardless  of 
the  preferences  of  shippers.  These  were  “exclusive” 
contracts.  But  the  Interstate  Commerce  Commission, 
acting  under  its  general  authority  to  forbid  discriminat¬ 
ing  rates  and  practices,  has  recently  declared  this  kind 
of  arrangement  to  be  an  attempt  to  compel  shippers 
to  employ  a  particular  water  line,  and  an  illegal  dis¬ 
crimination  against  shippers.2  It  was  declared  to  be 
illegal  for  a  railroad  to  give  the  use  of  its  facilities  ex¬ 
clusively  to  one  steamship  line,  unless  the  railroad 
would  undertake  to  deliver  to  other  ship  lines  at  an¬ 
other  wharf  for  the  same  charge.  The  railroad  may 
have  a  preferred  steamship  connection  so  long  as  such 
preference  does  not  involve  any  discrimination  against 
traffic  routed  via  the  railroad  over  a  non-preferred  boat 
line.  Exclusive  ”  agreements  have,  therefore,  largely 
given  place  to  “  preferential  ”  ones.3 

Control  of  wharf  space  by  conference  lines,  or  railroads, 
or  both,  is  sometimes  a  barrier  to  the  freest  commerce 


1  Cf.  Huebner,  Report  on  Steamship  Agreements  and  Affiliations  in  the  Ameri¬ 
can  Foreign  and  Domestic  Trade,  Vol.  IV,  p.  292. 

2  See  Interstate  Commerce  Commission  Reports,  XXIII,  pp.  417-428. 

8  Huebner,  Report  on  Steamship  Agreements  and  Affiliations,  p.  240. 


TRANSPORTATION  MONOPOLY 


85 


via  a  given  port.  Water  frontage  is  frequently  owned 
to  a  large  extent  by  railroad  interests.  Thus,  the  Lake 
front  in  Chicago,  opposite  the  business  section,  is  occu¬ 
pied  by  the  Illinois  Central  Railroad;  and  important 
parts  of  the  water  front  in  Buffalo,  N.  Y.,  Cleveland,  O., 
Norfolk,  Va.,  Mobile,  Ala.,  and  Oakland,  Cal.,  are  con¬ 
trolled  by  railroads.1  In  order  that  a  port  should  fulfill 
well  its  commercial  functions,  it  is  important  that  rail 
and  water  lines  should  come  close  together,  and  if  they 
are  to  do  so,  railroads  must  usually  have  some  frontage ; 
but  it  is  claimed  that  they  have  more  than  they  need  for 
this  purpose  and  that  their  holdings  are  a  barrier  in  the 
way  of  water  transportation  which  might  else  be  profit¬ 
able.  “In  many  cases  they  hold  large  tracts  of  unde¬ 
veloped  frontage  which  they  refuse  to  sell  or  lease,  and 
which  are  needed  for  the  construction  of  public  docks.” 2 
Where  railroads  thus  maintain  monopoly  of  traffic  which 
would  otherwise  be  shared  with  competing  navigation 
companies,  such  monopoly  must  be  assumed  to  be 
inimical  to  the  development  of  commerce.  At  Pitts¬ 
burgh,  St.  Louis,  and  other  river  points,  the  railroads  hold 
miles  of  frontage  beyond  what  is  required  for  their  own 
terminal  facilities,  which  might  otherwise,  it  is  urged,  be 
acquired  and  used  by  water  lines.3  At  some  ocean  ports, 
the  combined  holdings  of  railroad  and  large  steamship 
companies  have  been  such  that  it  has  been  difficult  for 
tramp  vessels  or  independent  boat  lines  to  obtain  landing 
privileges.4  Where,  as  in  the  case  of  the  port  of  New 

1  Report  of  the  Commissioner  of  Corporations  on  Transportation  by  Water 
in  the  United  States,  Part  I,  p.  155. 

2Final  Report  of  the  National  Waterways  Commission,  1912,  p.  21. 

3  Report  of  the  Commissioner  of  Corporations  on  Transportation  by  Water  in 
the  United  States,  Part  I,  1909,  p.  155. 

4  Ibid.,  p.  156. 


86  TRANSPORTATION  COSTS  OF  COMMERCE 


Orleans,1  there  is  extensive  public  ownership  and  public 
control  of  wharves,  it  is  possible  to  assure  wharf  space 
on  fair  terms  to  all  vessels.  Attention  has  elsewhere  2 
been  called  to  the  British  system  of  public  harbor  trusts 
and  its  advantage  for  harbor  management.  Where  a 
harbor  is  controlled  by  such  a  trust,  it  is  easily  possible  to 
avoid  exclusion  of  any  vessels. 

Another  condition  that  has  tended  towards  transporta¬ 
tion  monopoly  has  been  the  large  control  of  water  car¬ 
riers  themselves,  by  American  railroads.3  To  a  very 
considerable  extent  there  has  been  railroad  ownership 
of  vessels  engaged  in  the  Atlantic  Coast  trade,  the  Gulf 
trade,  and  the  Great  Lakes  trade,  vessels  which  might 
otherwise  be  competitors  of  railroads  for  the  traffic 
between  American  ports.  In  very  many  cases,  the  only 
regular  line  of  vessels  carrying  freight  between  two  or 
more  ports  has  been  controlled  by  a  railroad  company 
or  by  a  shipping  consolidation  4  (frequently  a  holding 
company).  It  is  now  provided,  however,  by  the  Panama 
Canal  Act  of  1912,  that  no  railroad  or  other  common 
carrier  subject  to  the  Interstate  Commerce  Act  shall  own, 
lease,  operate,  control,  or  have  any  interest  whatsoever 
(by  stock  ownership,  holding  company,  stockholders  or 
directors  in  common,  or  otherwise),  in  any  common  carrier 
by  water,  which  does  or  may  compete  with  it.  The 
Interstate  Commerce  Commission  has  jurisdiction  to 
decide,  in  each  case,  as  to  the  fact  of  possible  competition. 

1  Report  of  the  Commissioner  of  Corporations  on  Transportation  by  Water  in 
the  United  States,  Part  III,  pp.  70-102,  gives  a  full  discussion  of  the  organization 
of  this  port. 

2  Part  II,  Chapter  VIII,  §  5. 

s  Report  of  the  Commissioner  of  Corporations  on  Transportation  by  Water  in 
the  United  States,  Part  IV,  on  Control  of  Water  Carriers  by  Railroads  and  Ship¬ 
ping  Consolidations,  19x2,  Chapters  I  and  II. 

4  Ibid.,  p.  13. 


TRANSPORTATION  MONOPOLY 


87 


The  Function  of  Government  in  Relation  to  Transporta¬ 
tion  Monopoly 

Monopoly  in  transportation  may  be  reached  by  a 
variety  of  methods  and  is  frequently  secured,  as  we  have 
seen,  by  methods  which  do  not  at  all  signify  superior 
service  or  lower  rates.  However  secured  and  main¬ 
tained,  there  is  danger  that  such  monopoly  will  be  so  used 
as  to  decrease  commerce  and  lessen  the  general  welfare. 
Government  should  prevent,  so  far  as  possible,  the 
attainment  of  monopoly  by  unfair  practices  or  by  con¬ 
spiracy,  or  under  any  circumstances  which  make  it  detri¬ 
mental  to  the  general  welfare;  and,  where  monopoly 
appears,  government  should  protect  commerce  against 
possible  extortion.  Besides  establishing  and  maintaining 
an  adequate  money  and  banking  mechanism,  government 
may  be  said  to  have  at  least  two  important  functions  with 
regard  to  commerce,  a  negative  and  a  positive  one.  The 
negative  function  of  government  is  to  avoid,  itself, 
interfering  with  the  normal  course  of  trade  by  tariff 
restrictions,  bounties,  navigation  acts,  or  other  special 
privileges.  The  positive  function  of  government  is  to 
prevent  interference  with  trade  and  diversion  of  trade  out 
of  its  natural  channels,  by  monopolistic  or  discriminat¬ 
ing  transportation  rates.  On  the  other  hand,  when  the 
principle  of  rate  regulation  by  government  is  thoroughly 
established,  care  must  be  taken  not  to  require  rates  so  low 
as  to  discourage  the  investment  of  capital  in  needed 
transportation  facilities,  since  inadequate  facilities,  no 
less  than  high  rates,  may  prevent  the  fullest  profitable 
development  of  trade. 

Properly  to  regulate  the  rates  of  monopolistic  trans- 


88  TRANSPORTATION  COSTS  OF  COMMERCE 


portation  companies  is  a  task  of  considerable  difficulty, 
yet  a  task  which,  through  commissions  or  otherwise, 
government  must  apparently  perform.  What  standards 
of  reasonableness  should  be  applied  when  such  regulation 
is  undertaken  ?  Provided  transportation  facilities,  e.g. 
a  railroad,  are  needed  for  the  carriage  of  goods  between 
certain  points,  provided  the  route  is  wisely  chosen  and 
the  management  reasonably  good,  the  rates  allowed 
should  yield  enough  to  pay  all  expenses,  to  pay  a  reason¬ 
able  profit  on  the  cost  of  construction,  or  more  nearly, 
perhaps,  what  the  cost  of  construction  would  now  1  be, 
if  the  road  had  to  be  built  again,  and  to  pay,  also,  a 
reasonable  rent  on  the  land  used  for  right  of  way  and 
stations.2  Public  regulation  must  allow  reasonable 
profit  to  such  a  company,  else  investors  will  prefer  to 
devote  their  capital  to  other  uses.  And  unless  the 
profit  allowed,  above  interest  on  the  construction  cost, 
amounts  to  as  great  a  surplus  as  the  necessary  land  space 
would  yield  in  some  other  use,  the  application  of  land  to 
the  requirements  of  transportation  will  be  discouraged. 
If  increased  population  adds  to  the  returns  which  the 
land  would  yield  in  some  other  use,  it  should  ordinarily 
add  to  the  returns  which  the  same  land  yields  when 
devoted  to  the  transportation  use.  These  larger  returns 
will  usually  be  yielded  without  the  necessity  of  rate 
increases  or,  in  some  cases,  even  though  rates  fall,  since 
growth  of  population  tends  to  increase  traffic.  But  to 
force  rate  reduction  to  such  a  point  as  to  prevent  the 

If  values  change,  this  cost  of  duplication  should  be  emphasized  in  so  far  as 
it  would  have  influence  in  purely  competitive  businesses  of  large  plants.  In  such 
a  business,  the  existing  prices  are  dependent  largely  on  past  cost  of  construction, 
for  if  that  was  very  great,  there  will  be  fewer  plants  now  in  operation.  But  a 
decrease  in  the  necessary  cost  of  construction  is  likely  to  encourage  the  building 
of  new  plants,  whose  competition  will  soon  influence  prices. 
a  Cf.  Chapter  I  (of  Part  III),  §3. 


TRANSPORTATION  MONOPOLY 


89 


realization  of  any  gain,  on  the  theory  that  the  gain  is 
unearned,  is  to  discriminate  unduly  against  the  owners 
of  land  used  for  the  purpose  of  transportation.  It  is 
not  intended  to  argue  that  increases  in  the  rental  value 
of  land  should  go  to  private  individuals  or  to  corpora¬ 
tions  rather  than  to  the  public.  To  tax  these  in¬ 
creases  heavily  wherever  they  occur  may  be  a  desirable 
economic  policy.  Where  this  policy  is  followed,  the 
owners  of  any  land  will  be  as  careful  as  now  to  use  it 
in  the  way  that  brings  the  largest  gain,  since  the  tax, 
being  based  on  the  natural  and  situation  advantages  of 
the  land,  will  be  the  same  regardless  of  how  these  owners 
choose  to  use  it.1  But  to  rule  that  if  the  land  is  used  for 
most  purposes,  such  a  gain  in  value  will  be  allowed  to 
accrue  to  its  owners ;  while  if  it  is  used  for  one  particular 
purpose,  this  gain  shall  go  to  the  public,  is  to  encourage 
the  other  uses  and  discourage  the  one  use. 

On  the  other  hand,  government  is  not  under  obligation 
so  to  regulate  rates  as  to  protect  a  transportation  com¬ 
pany  even  in  the  enjoyment  of  profits  only  equal  to  the 
average  in  competitive  business,  when  this  company  has 
been  mismanaged.2  Companies  engaged  in  strictly 
competitive  business  do  not  enjoy  average  profits 
unless  managed  with  average  ability.  Nor  is  a  railroad 
between  two  points,  which  has  been  laid  out  over  an 
unnecessarily  devious,  and,  therefore,  a  relatively  un¬ 
profitable,  route,  entitled  to  charge,  in  consequence, 
higher  rates  on  traffic  between  those  points,  so  as  to  make 

1  If  the  tax  were  made  higher  just  because  the  owner  chose  to  make  a  more 
profitable  use  of  the  land  than  others  had  seen  the  possibility  of,  the  best  use  of 
land  would  be  discouraged.  Cf.  Marshall,  Principles  of  Economics,  6th  edition, 
London  (Macmillan),  1910,  p.  434. 

*  See  views  of  the  Interstate  Commerce  Commission,  asset  forth  in  the  “Five 
Per  Cent  case,”  Interstate  Commerce  Commission  Reports,  Vol.  XXXI,  pp. 
358,  359  (PP-  351-454  for  entire  case). 


90  TRANSPORTATION  COSTS  OF  COMMERCE 

as  great  profits,  at  the  expense  of  the  public,  as  if  it  had 
been  wisely  located.1  The  same  conclusion  may  of  course 
follow  if  the  route  chosen  can  provide  little  intermediate 
traffic,  and  if  a  more  profitable  route,  providing  more 
intermediate  traffic,  was  available.  In  competitive 
business,  owners  are  obliged  to  suffer  diminution  of 
profits  when  mistakes  are  made.  Where  there  is  real 
competition  between  several  railroad  companies,  the  un¬ 
wisely  located  line  finds  itself  at  a  serious  disadvantage. 
Any  combination  or  agreement  which  should  insure  to 
such  a  line  a  profit  as  great  as  it  could  have  expected  if 
well  located  would  be  inimical  to  public  welfare.  Of 
course  a  railroad  built  where  traffic  is  light,  provided 
it  was  built  so  as  to  connect,  by  the  best  available 
route,  the  principal  points  served,  is  fairly  entitled  to 
charge  the  high  rates  necessary  to  secure  a  reasonable 
profit. 

Competition  stimulates  to  good  management.  Public 
regulation  of  a  business  which  is,  by  necessity,  a  partial 
monopoly,  perhaps  may  not,  at  best,  stimulate  efficiency 
as  much.  But  unless  regulation  is  so  applied  as  to  make 
profits  depend  in  part  on  good  management,  such  man¬ 
agement  is  likely  to  be  had  to  a  decreasing  degree,  rates 
are  likely  to  be  high,  and  commerce  to  be  retarded.  Yet 
it  would  not  be  fair  to  require,  as  a  condition  precedent 
to  allowing  reasonable  profits,  a  standard  of  management 
far  superior  to  that  common  in  other  industries.  Rea¬ 
sonably  good  management  should  bring  reasonably  good 
returns,  and  exceptional  management  should  bring 
returns  above  the  average.  The  Interstate  Commerce 


1  Cf.  views  of  the  Interstate  Commerce  Commission,  as  set  forth  in  the  “  Five 
Per  Cent  case,”  Interstate  Commerce  Commission  Reports,  Vol.  XXXI, 
P-  359- 


TRANSPORTATION  MONOPOLY 


9i 


Commission  has  said : 1  “A  premium  must  be  put  upon 
efficiency  in  the  operation  of  the  American  railroad. 
Rates  cannot  be  increased  with  each  new  demand  of 
labor,  or  because  of  wasteful,  corrupt,  or  indifferent 
management.  Nor  should  rates  be  reduced  with  each 
succeeding  improvement  in  method.  Society  should 
not  take  from  the  wisely  managed  railroad  the  benefits 
which  flow  from  the  foresight,  skill,  and  planned  cooper¬ 
ation  of  its  working  force.  We  may  ruin  our  railroads 
by  permitting  them  to  impose  each  new  burden  of  obliga¬ 
tion  upon  the  shipper.  And  we  can  make  no  less  sure 
of  their  economic  destruction  by  taking  from  them  what 
is  theirs  by  right  of  efficiency  of  operation  —  the  elimina¬ 
tion  of  false  motion,  of  unneeded  effort,  and  the  conser¬ 
vation  of  labor  and  materials.  The  standard  of  rates 
must  be  so  high  that  the  needed  carrier  which  serves  its 
public  with  honesty  and  reasonable  effort  may  live.  And 
yet  rates  should  be  still  so  much  below  the  possible  maxi¬ 
mum  as  to  give  high  and  exceptional  reward  to  the 
especially  capable  management,  the  well- coordinated 
force  and  plant.  This  is  the  ideal,  unrealizable  perhaps, 
but  it  points  the  way.” 

In  the  fixing  of  rates,  the  par  value  of  stocks  and  bonds 
of  a  company  may  be  a  consideration  of  importance  as 
indicating  original  investment.  But  where  stock  water¬ 
ing  has  been  attempted,  par  value  has  no  significance. 
Market  value  of  securities  cannot  be  regarded  as  a  satis¬ 
factory  standard  for  rate  fixing,  since  market  value 
depends  mainly  on  profits,  which  in  turn  depend  chiefly 
on  rates.  Even  if  the  original  investment  can  be  ascer¬ 
tained,  changes  in  values,  particularly  in  regard  to  land, 

1  Ibid.,  Vol.  XX,  p.  334  (pp.  307-399  for  entire  case).  Cf.  Vol.  XXXI,  p.  358 
(in  the  “  Five  Per  Cent  case,”  pp.  351-454). 


92  TRANSPORTATION  COSTS  OF  COMMERCE 


may  make  this  original  investment  an  unsatisfactory 
measure  of  present  physical  value.1  A  physical  valuation 
of  transportation  plant,  such  as  the  Interstate  Commerce 
Commission  is  now  carrying  out 2  for  railroads  of  the 
United  States,  may  provide  an  important  standard  by 
which  to  judge  profits  and  rates. 

§  5 

Summary 

In  this  chapter  we  have  seen  that  railroads  are  partial 
monopolies  in  that  there  are  almost  always  intermediate 
points  served  by  only  one  line.  As  to  points  served  by 
more  than  one  line,  we  have  seen  that  formal  rate  agree¬ 
ments  and  pooling  agreements  have  been  common  among 
competing  railways,  but  that  such  agreements  are  now 
illegal.  Competition  among  railways  may  be  ruinous 
to  the  competing  companies  if  facilities  are  in  excess  of 
possible  business,  but  is  not  otherwise  necessarily  so. 

Transportation  on  the  ocean  is,  by  virtue  of  the  fact 
that  a  route  does  not  have  to  be  constructed,  less  sub- 


1  In  Smyth  v.  Ames ,  169  U.  S.,  466,  the  Supreme  Court  has  laid  down  as  fol¬ 
lows  the  matters  to  be  considered  (see  particularly  p.  455) :  “We  hold,  however, 
that  the  basis  of  all  calculations  as  to  the  reasonableness  of  rates  to  be  charged 
by  a  corporation  maintaining  a  highway  under  legislative  sanction  must  be  the 
fair  value  of  the  property  being  used  by  it  for  the  convenience  of  the  public. 
And,  in  order  to  ascertain  that  value,  the  original  cost  of  construction,  the  amount 
expended  in  permanent  improvements,  the  amount  and  market  value  of  its 
bonds  and  stocks,  the  present  as  compared  with  the  original  cost  of  construction, 
the  probable  earning  capacity  of  the  property  under  particular  rates  prescribed 
by  statute,  and  the  sum  required  to  meet  operating  expenses  are  all  matters  for 
consideration,  and  are  to  be  given  such  weight  as  may  be  just  and  right  in  each 
case.  We  do  not  say  that  there  may  not  be  other  matters  to  be  regarded  in 
estimating  the  value  of  the  property.”  That  the  Supreme  Court  would  be 
inclined,  however,  to  put  chief  emphasis  on  a  physical  valuation,  seems  to  be 
indicated  by  its  discussion  in  the  recent  Minnesota  Rate  case,  230  U.  S.,  352. 

2  By  an  Act  of  March  1,  1913. 


TRANSPORTATION  MONOPOLY 


93 


ject  to  monopoly  control  than  rail  transportation.  But 
agreements  among  water  carriers  have  been  common,  and 
the  field  of  competition  has  been  thus  considerably 
limited.  Furthermore,  various  devices,  such  as  deferred 
rebates  and  fighting  ships,  have  been  adopted  to  destroy 
the  competition  of  independent  lines.  Exclusive  ar¬ 
rangements  with  railways,  and  control  of  wharf  space 
by  conference  lines  and  by  railways,  have  also  served  to 
make  independent  competition  difficult. 

Monopolistic  rates,  like  protective  tariffs,  may  serve 
to  interfere  with  commerce  which  ought,  for  the  general 
economic  welfare,  to  take  place.  As  government  should 
itself  avoid  undue  interference  with  commerce  through 
the  establishment  of  protective  tariffs,  bounties,  naviga¬ 
tion  acts,  or  other  special  favors,  so  also  it  should  prevent, 
directly  or  indirectly,  any  economically  injurious  inter¬ 
ference  with  commerce,  which  private  interests  might 
occasion  through  the  charging  of  monopolistic  trans¬ 
portation  rates.  Yet  in  thus  protecting  commerce 
against  the  exactions  of  private  monopoly,  government 
regulation  must  avoid  enforcing  rates  so  low  that  capital 
will  not  be  forthcoming  for  transportation  requirements. 
The  rates  fixed  should  be  such  as  will  yield,  with  reason¬ 
ably  good  management,  the  average  rate  of  return  on 
capital  invested  in  construction,  and  a  fair  return  or  rent 
on  the  land  requisite  for  way  and  terminals. 


CHAPTER  IV 


Economically  Undesirable  Rate  Discrimination 

among  Places 

§  i 

Competition  as  a  Cause  of  Discrimination  among  Places 

Discrimination  in  rates,  among  places,  is  chiefly  due 
to  the  existence  of  effective  competition  among  trans¬ 
portation  companies  at  some  places  and  not  at  others. 
Thus,  two,  three,  or  more  railroads  may  connect  A  and 
C,  while  B  is  on  the  line  of  only  one.  (See  figure  8.) 


Figure  8 


Competition  among  the  several  railroads  for  traffic 
from  A  to  C  and  from  C  to  A  will  make  rates  on  this 
traffic  low,  while  the  absence  of  competition  for  the 
shorter  distance  traffic  will  make  rates  from  A  to  B, 
B  to  A,  B  to  C,  and  C  to  B  comparatively  high  in  pro¬ 
portion  to  service  rendered  (or  distance  the  goods  are 
carried). 


94 


UNDESIRABLE  PLACE  DISCRIMINATION  95 


The  competition  which  introduces  this  inequality  of  . 
rates  need  not  be  competition  of  routes.  It  may  also 
be  competition  of  directions,  competition  of  locations, 
or  even  competition  with  local  self-sufficiency.1  Con¬ 
sider  one  of  our  illustrations  of  competition  of  directions, 
in  a  previous  chapter,  where  we  assumed  the  railroad 
AC  (see  figure  9)  to  make  a  low  rate  on  coal  from  A  to 


C,  in  order  to  prevent  the  coal  produced  at  A  from  being 
shipped  almost  entirely  over  the  line  AB.  In  this  illus¬ 
tration,  the  railroad  AC  is  not  compelled  by  competition 
of  directions  to  make  low  rates  from  A  to  G,  for  G  can¬ 
not  secure  coal  over  any  other  railroad ;  or  from  F  to  G, 
or  from  F  to  C,  for  F  has  not  the  choice  of  shipping  over 
another  fine.  These  intermediate  rates  may  therefore 
be  appreciably  higher,  in  relation  to  the  distance  the 
intermediate  traffic  is  carried. 

In  the  case  of  competition  of  locations,  also,  all  points 
are  not  equally  benefited.  Thus,  though  the  line  EDA 
(see  figure  10)  makes  low  rates  on  goods  carried  from 

1  See  Chapter  II  (of  Part  III),  §§  x,  3,  4,  5. 


96  TRANSPORTATION  COSTS  OF  COMMERCE 


D  to  A,  lest  certain  industries  be  located  entirely  at  B 
instead  of  partly  at  D,  it  may  not  need  to  make  corre¬ 
spondingly  low  rates  from  D  to  F.  For  in  F  the  pro¬ 
ducers  at  D  do  not  feel  to  the  same  extent  as  in  A,  the 
competition  of  their  rivals  at  B.  High  railroad  rates 
from  D  to  F  may  be  shifted  upon  the  consumers  at  F, 
in  the  prices  of  the  goods  carried.  The  burden  of  high 
rates  to  A,  however,  must  fall  upon  the  producers  at  D 


and  may  cause  them  to  abandon  the  market  and,  per¬ 
haps,  the  business.  In  any  case,  it  is  likely  to  decrease 
the  traffic  of  railroad  EDA .  Hence,  lower  rates  may  be 
made  by  the  railroad  on  traffic  to  A  than  on  traffic  to  F. 

If  the  competition  is  with  local  self-sufficiency,  there  is 
a  like  reason  for  discrimination.  A  railroad  connecting 

B 

A-^- - % - %  c 

Figure  ii 

A  (see  figure  ii),  a  center  of  coal  production,  with  C, 
where  coal  could  be  mined  somewhat  less  advanta- 


UNDESIRABLE  PLACE  DISCRIMINATION  97 


geously,  may  make  a  low  rate  on  coal  from  A  to  C,  as 
the  only  way  to  get  the  traffic.  But  it  will  not  be 
under  similar  compulsion  to  make  an  equally  low  rate 
from  A  to  B. 

Discrimination  between  places  occurs  in  water  trans¬ 
portation  also.  At  one  time  the  White  Star  Line  carried 
goods  from  New  York  via  Liverpool  to  Australia  at 
rates  30  per  cent,  lower  than  the  rates  charged  on  the 
same  kinds  of  goods  carried  on  the  same  vessels  from 
Liverpool  to  Australia.  This  was  due  to  competition 
for  the  through  business,  with  the  direct  lines  from  the 
United  States.1 

§  2 


Economic  Loss  which  May  Flow  from  Discrimination 

among  Places 

Let  us  now  consider  the  effects,  on  all  interests  con¬ 
cerned,  and  on  general  community  welfare,  of  discrimi- 

C 


nation  among  places,  as  it  has  been  very  generally 
practiced  by  transportation  companies.  We  may  begin 
with  place  discrimination  caused  by  competition  of  two 

1  Huebner,  Report  on  Steamship  Agreements  and  Affiliations  in  the  American 
Foreign  and  Domestic  Trade,  in  Proceedings  of  the  Committee  on  the  Merchant 
Marine  and  Fisheries  in  the  Investigation  of  Shipping  Combinations,  1914,  Vol. 
IV.,  p.  106. 


PART  in  —  H 


98  TRANSPORTATION  COSTS  OF  COMMERCE 

or  more  railroads  with  each  other.  Suppose  two  roads 
joining  the  cities  A  and  B  (see  figure  12),  C  being  a 
town  or  city  on  one  of  the  roads  only,  and  D  a  town  or 
city  on  the  other.  Competition  makes  rates  from  A  to 
B  lower  than  from  C  to  B  and  lower  than  from  D  to  B. 

Looking  at  this  discrimination  from  the  standpoint  of 
either  road  and  the  constituency  it  serves,  and  assuming 
conditions  to  be  fixed  for  this  road  by  the  policy  of  the 
other,  the  discrimination  seems  to  be  entirely  justifiable. 
If  C  complains  of  injustice  in  the  rates  charged,  say, 
from  C  to  B  as  compared  with  the  rates  from  A  to  B,  the 
railroad  ,4  GB  has  a  ready  answer.  It  is  compelled  to 
make  a  low  rate  from  A  to  B  and  vice  versa,  because  of 
the  competition  of  the  line  ADB,  or  forego  all  traffic 
between  those  points.  Yet  this  traffic  pays  the  terminal 
expenses  involved  and  the  necessary  expenses  for  the 
production  of  train  mileage.  It  leaves,  also,  we  must 
suppose,  some  small  surplus  to  apply  towards  the  general 
expenses,  if  not  towards  fixed  charges  or  profits.  Other¬ 
wise,  it  would  not  be  worth  competing  for.  Had  it 
been  supposed  that  the  railroad  ACB  was  not  to  be 
allowed  to  seek  a  share  of  this  traffic,  which,  in  the  sense 
noted,  is  paying  traffic,  the  railroad  might  never  have 
been  built.  It  has  been  built,  and,  therefore,  is  able  to 
serve  C  also,  only,  perhaps,  because  of  the  competitive 
traffic  of  which  it  secures  a  part.  Without  this  traffic 
it  would  not  even  pay  to  continue  business,  so,  probably, 
only  partially  utilizing  the  plant,  unless  the  traffic  to 
and  from  C,  together  with  other  intermediate  traffic, 
could  pay  high  enough  charges  to  cover  all  general  ex¬ 
penses  and  something  over.  On  the  other  hand,  to 
charge  rates  on  traffic  to  and  from  C ,  and  on  other  in¬ 
termediate  traffic,  as  low  accordingly  as  on  traffic  which 


UNDESIRABLE  PLACE  DISCRIMINATION  99 


is  competitive,  would  probably  mean  lack  of  fair  profit 
and,  conceivably,  even  abandonment.  The  conclusion 
is  drawn,  then,  that  all  these  parties  concerned  really 
benefit  by  the  discrimination.  A  and  B  get  low  rates. 
The  line  ACB  gets  traffic  which  helps  it  to  meet  general 
expenses  and  to  pay  interest  and  dividends.  C  gets  the 
service  of  the  line  ACB,  which  it  could  not  get,  or 
could  not  get  at  such  low  rates,  if  ACB  were  prevented 
from  securing,  even  at  relatively  discriminating  rates, 
the  longer  distance  business. 

The  above  is  essentially  the  argument  usually  pre¬ 
sented  to  justify  discrimination  between  places.  But 
this  argument  leaves  certain  important  facts  out  of 
account.  To  begin  with,  the  reason  why  the  traffic 
from  A  to  B  is  carried  at  low  rates  is  only  because  there 
happen  to  be  two  lines  serving  A  and  B  as  compared 
with  one  line  each  serving  C  and  D  respectively,  and  not 
necessarily  because  the  cities  A  and  B  are  naturally 
any  better  located  for  business  than  C  and  D.x  When 
we  come  to  consider  the  matter  of  utilization  of  both 
roads,  we  do  not  find  that  the  discrimination  increases 
it.  The  low  rates  from  A  to  B  are  not  made  because 
the  total  traffic  between  those  points  will  decrease  if 
they  are  not  made ;  they  are  not  due  to  the  fear  that  the 
traffic,  as  a  whole,  can  bear  no  higher  rates  without  being 
destroyed.  On  the  contrary,  each  road  makes  these  low 
rates  in  the  fear  that  otherwise  its  traffic  will  decrease 
to  the  profit  of  the  competing  road,  in  the  fear  that  the 
traffic  between  A  and  B  cannot  bear  higher  rates  without 
being  diverted.  As  regards  the  effect  of  low  rates  on 


1  Though,  of  course,  the  larger  populations  of  A  and  B,  if  those  were  relatively 
large  cities  before  the  building  of  the  roads,  may  have  been  a  reason  why  more 
than  one  company  sought  entrance  to  them. 


ioo  TRANSPORTATION  COSTS  OF  COMMERCE 

total  traffic,  it  is  entirely  possible  that  a  reduction  of 
rates  in  favor  of  C  would  increase  traffic  to  and  from  C, 
fully  as  much  as  reduction  between  A  and  B  increases 
the  total  traffic  from  A  to  B  and  B  to  A .  As  far,  then, 
as  the  matter  of  complete  utilization  of  existing  railroad 
plants  is  concerned,  there  is  little  if  any  more  reason  — 
perhaps,  sometimes,  less  reason  —  for  reducing  the  AB 
rates,  than  for  reducing  the  AC  and  the  CB ,  the  AD 
and  the  DB ,  rates.  The  AB  rates  are  reduced  only 
because  each  road  wants  its  facilities  fully  utilized,  if 
possible,  even  at  the  expense  of  the  other,  and  not  be¬ 
cause  the  reduction  is  likely  so  to  increase  traffic  as 
more  fully  to  utilize  the  facilities  of  both.  As  regards 
this  phase  of  the  economic  results,  there  is  no  special 
gam  from  the  d'lscvTwi'i'yicit'iO'yi ,  as  such,  whatever  gain 
might  result  from  an  all-around  rate  reduction.  It  is 
true  that  up  to  the  point  of  full  utilization  of  plant,  rail¬ 
roads  are  operated  under  the  principle  of  increasing 
returns,  that  up  to  that  point,  large  traffic  is  carried 
proportionally  more  cheaply  than  small  traffic,  and  that, 
therefore,  large  traffic,  bringing  this  full  utilization,  is 
desirable.  But  it  is  also  true  that  complete  utilization 
of  all  existing  plant,  i.e.  of  both  railroads,  will  probably, 
in  the  circumstances  under  discussion,  be  no  more 
furthered  by  low  competitive  rates  than  by  low  non¬ 
competitive  rates.  There  is  no  additional  economy  in 
utilization,  resulting  from  discrimination  as  such. 

Since  the  competition  of  the  two  railroads,  and  the 
consequent  discrimination,  favors  A  and  B  at  the 
expense  of  C  and  D,  it  results  that  A  and  B  develop 
more  rapidly  than  their  natural  advantages  would  seem 
to  warrant ;  while  C  and  D  develop  less  rapidly,  have 
their  development  retarded,  or  are  even  made  to  decline 


UNDESIRABLE  PLACE  DISCRIMINATION  ioi 


in  industry,  wealth,  and  population,  by  the  disadvantages 
to  which  they  are  thus  subjected.  If  no  rate  differences 
were  made,  other  than  those  compelled  by  differences 
in  actual  cost,  i.e.  if  the  distance  principle  were,  in 
situations  like  the  one  here  discussed,  consistently  ap¬ 
plied,  then  the  places  naturally  favored  would  be  the 
ones  to  develop,  rather  than  those  favored  by  the  fact 
—  sometimes,  in  a  sense,  the  accident  —  of  being  served 
by  two  or  more  railroads.  Discrimination  many  times 
deprives  cities  or  districts  of  the  benefits  which  would 
result  to  them  from  their  natural  advantages.  In  so 
far  as  it  actually  does  this,  and  tends  to  develop  industry 
where  the  natural  advantages  of  industry  are  less  good, 
it  lessens  the  wealth-producing  power  and,  consequently, 
the  prosperity,  of  the  country.  It  prevents  the  develop¬ 
ment  of  industry  where  it  should  develop,  and  encour¬ 
ages  its  development  where  it  should  not.  It  may  not, 
like  a  protective  tariff,  divert  effort  into  relatively  un¬ 
profitable  lines  of  production;  but  is  more  likely  to 
cause  those  lines  of  production  which  would  in  any 
case  be  chosen,  to  be  carried  on  in  relatively  disad¬ 
vantageous  localities.  Rate  discrimination  between 
places  resembles  protection,  to  some  extent,  in  that  it 
may  benefit  some  localities  of  the  country  at  the  expense 
of  others.1 

This  discrimination  may  also  bring  about  undesirable 
or  uneconomical  transportation.  There  may,  for  in¬ 
stance,  be  industries  for  which  C  has  as  great  advantages 
as  A ,  or  even  greater  advantages,  the  products  of  which 
are  marketed  largely  in  B ;  yet  discrimination  in  rates 
causes  these  industries  to  be  located  at  A.  The  conse¬ 
quence  is  that  goods  have  to  be  carried  from  A  to  B, 

1  Cf.  Part  II,  Chapter  V,  §  6. 


102  TRANSPORTATION  COSTS  OF  COMMERCE 

over  a  comparatively  long  distance,  which  might  be 
carried  from  C  to  B,  a  relatively  short  distance.  More 
labor  has  to  be  expended  that  the  community  may 
attain  a  given  result.  In  this  possible  consequence, 
also,  discrimination  between  places  resembles  the  pro¬ 
tective  tariff.  The  same  objections  apply  if  the  dis¬ 
crimination  between  places  is  caused  by  competition  of 
directions  or  competition  of  locations.  The  existing  le¬ 
gal  limitation  and  prohibition  of  discrimination  between 
places  tends  to  .  raise,  in  this  regard,  the  plane  of  com¬ 
petition,  and  would  seem,  therefore,  to  be  justified.  Sec¬ 
tion  4  of  the  Interstate  Commerce  Law  prohibits  a 
greater  charge  for  a  shorter  distance  than  for  a  longer 
one  over  the  same  line  in  the  same  direction  when  the 
shorter  distance  is  included  in  the  longer,  except  by 
permission  of  the  Interstate  Commerce  Commission ; 
while  section  3  prohibits  any  undue  discrimination 
between  places.  What  is  undue  discrimination  in  any 
specific  case,  where  there  is  complaint  or  where  investi¬ 
gation  is  made,  is  decided  by  the  Commission. 

Complete  prohibition  of  discrimination  among  places 
(except  under  special  circumstances  to  be  discussed  in 
the  next  chapter)  does  away  with  the  economic  wastes 
above  discussed  and  is,  in  so  far,  economically  desirable. 
But  in  some  cases  its  enforcement  may  involve  consider¬ 
able  hardship  to  the  railroads  affected.  If  the  rivalry 
of  these  railroads  to  secure  the  competitive  traffic  is 
keen  and  if  this  competitive  traffic  is  important,  the 
competing  railroads  may  feel  obliged  to  make  corre¬ 
spondingly  low  rates  on  their  intermediate  traffic  —  when 
forbidden  to  discriminate  —  instead  of  venturing  to 
correct  the  discrimination,  in  part,  by  raising  rates  on 
the  longer  distance  traffic.  Such  a  situation  might  mean 


UNDESIRABLE  PLACE  DISCRIMINATION  103 


that  the  general  level  of  rates  would  be  unremunerative, 
that  profits  could  not  be  had,  perhaps  that  fixed  charges 
could  not  be  paid.  It  might  be  well,  therefore,  if  Con¬ 
gress  would  legalize  rate  agreements  and  pooling,  when 
consented  to  and  supervised  by  the  Interstate  Commerce 
Commission,  so  that  cases  of  this  sort  could  be  settled 
with  entire  fairness  and  common  sense.  But  it  should 
not  be  forgotten  that  in  very  many  cases  the  traffic 
which  is  not  directly  competitive  is  an  important  part 
of  the  whole,  that  the  railroads  concerned  would  not  be 
willing  greatly  to  lower  their  rates  on  it,  even  though 
compelled  not  to  discriminate,  but  that  they  would 
prefer,  each,  to  risk  the  loss  of  some  competitive  traffic, 
by  maintaining  their  rates  on  that  traffic.  All  of  them 
would  probably  continue  to  get,  therefore,  a  share  of 
the  competitive  traffic.  In  such  cases,  at  least,  it  is 
not  necessary  to  legalize  pooling  in  order  to  enforce 
equality  of  treatment  without  great  injury  to  the  rail¬ 
roads.  Nor  is  pooling  a  necessary  measure  when  traffic 
is  sufficient  to  tax  all  the  roads.  As  a  matter  of  actual 
practice,  we  do  not  allow  pooling  or  formal  rate  agree¬ 
ments,  and  we  do,  not  altogether  unsuccessfully,  pro¬ 
hibit  rate  discrimination. 

§  3 

The  Uneconomy  of  Discrimination  either  in  Favor  of  or 

against  Imports 

A  special  class  of  discriminations,  to  which  these 
objections  would  apply,  is  that  of  discriminations  by 
railroads,  in  connection  sometimes  with  navigation  lines, 
against  domestic  and  in  favor  of  imported  goods.  In  a 
case  brought  before  the  Interstate  Commerce  Commis- 


io4  TRANSPORTATION  COSTS  OF  COMMERCE 

sion,  in  1905-1907, 1  it  appeared  that  there  was  rate  dis¬ 
crimination  against  domestic  plate  glass  and  in  favor  of 
the  imported  product.  On  the  domestic  product,  in 
trunk-line  territory,  third-class  rates  applied,  whereas 
shipments  from  foreign  producing  points  via  American 
ports  and  thence  to  interior  towns  and  cities  were  given 
fourth-  and  fifth-class,  and  even  lower,  rates.  It  was 
complained,  for  example,  that  plate  glass  could  go  from 
Antwerp,  Belgium,  to  Chicago,  by  way  of  Boston  and 
the  New  York,  New  Haven  and  Hartford  Railroad,  at 
40  cents  a  hundred  pounds  for  the  entire  distance,'  or 
(as  assumed  by  the  Interstate  Commerce  Commission) 
30  cents  for  the  share  of  the  railroads,  as  compared  with 
a  rate  of  50  cents  a  hundred  pounds  on  domestic  plate 
glass  from  Boston  to  Chicago.  Between  Antwerp  and 
Chicago,  via  New  Orleans  and  the  Illinois  Central  Rail¬ 
road,  5200  miles,  the  entire  rate  was  32  cents,  or  about 
22  cents  for  the  rail  part  of  the  haul,  as  compared  with 
75  cents  asserted  to  be  the  rate  from  New  Orleans  to 
Chicago  on  the  domestic  product.  These  differences 
were  presumably  due  to  competition,  the  railroads  com¬ 
peting,  in  connection  with  the  ocean  carriers,  for  the 
carriage  of  the  foreign  glass,  which  might  come  by  way 
of  any  port,  but  competing  apparently  much  less  for 
the  traffic  from  one  point  to  another  within  the  coun- 
try,  which  had  a  more  limited  choice  of  routes.2 

The  effect  of  such  discrimination,  in  general,  whatever 
its  effect  might  have  been  in  this  particular  case,  must 
be  to  discourage  home  production,  and,  therefore,  to 
turn  industry  away  from  a  line  which  it  would,  perhaps, 

1  Interstate  Commerce  Commission  Reports,  Vol.  XIII,  pp.  87-102.  Cf.  an 
earlier  case  in  Interstate  Commerce  Commission  Reports,  Vol.  IV,  pp.  447-534 

.  2  At  the  time  tMs  complaint  was  brought,  the  Interstate  Commerce  Com¬ 
mission  did  not  have  its  present  power  to  prevent  or  correct  such  discriminations. 


UNDESIRABLE  PLACE  DISCRIMINATION  105 


naturally  follow.  May  not  this  be  as  greatly  uneco¬ 
nomical  as  the  policy  of  the  protective  tariff  ?  If  goods 
can  really  be  produced  more  cheaply  abroad  than  in  the 
United  States,  including  cost  of  transportation,  it  is 
more  profitable  for  us  to  buy  such  goods  abroad  than 
to  produce  them  here,  but  the  same  conclusion  does  not 
follow  if  home  production  is  made  more  expensive  to 
consumers  because  of  an  artificial  barrier  raised  against 
the  home-produced  article.1 

Let  us  note,  specifically,  the  influence  of  such  dis¬ 
crimination  upon  the  different  interests  concerned. 
The  railroads,  taken  as  a  whole,  have  no  more  to  gain 
from  traffic  in  plate  glass,  or  other  goods,  produced 
abroad,  than  from  the  same  traffic  originating  on  the 
boundaries  of  our  own  country,  or  even  than  from 
traffic  originating  farther  inland,  if  the  rate  pays  as  large 
a  surplus  above  the  incident  cost.  Each  company 
lowers  rates  on  the  imported  product  only  to  divert 
traffic  from  a  rival  or  to  keep  traffic  which  otherwise 
might  be  diverted  to  rivals.  Taking  the  roads  as  a 
whole,  it  is  not  to  be  assumed  that  low  rates  on  im¬ 
ported  goods  increase  the  quantity  of  goods  they  carry, 
any  more  than  would  correspondingly 2  low  rates  on  the 
same  goods  produced  in  the  United  States. 

From  the  point  of  view  of  domestic  producers,  the 
discriminating  rates  are  a  discouragement.  From  the 
point  of  view  of  domestic  consumers,  —  in  the  case 


1  In  this  particular  case,  the  artificial  barrier  was  a  partial  offset  against  tariff 
protection.  We  shall  deal  here,  however,  with  the  rate  discrimination  considered 
by  itself. 

2  By  correspondingly  low  rates  is  here  meant  not  necessarily  rates  the  same 
per  mile  regardless  of  distance,  but  rates  which,  for  the  same  amount  of  goods 
carried,  would  yield  the  same  surplus  for  general  expenses,  fixed  charges,  and 
profits,  above  the  special  additional  cost  of  carrying  the  goods. 


io6  TRANSPORTATION  COSTS  OF  COMMERCE 


cited,  buyers  of  plate  glass,  e.g.  at  Chicago,  —  the  im¬ 
portant  point  is  that  the  glass  should  be  procurable  at 
the  lowest  possible  price.  They  do  not  care  where  it 
comes  from  so  long  as  price  and  quality  are  satisfactory. 
If  the  railroads  make  unduly  low  rates  on  the  imported 
product,  domestic  consumers  gain  no  more  than  the 
railroads  sacrifice.  If  American  producers,  without  the 
discrimination  to  contend  against,  could  undersell  their 
foreign  rivals,  in  the  Chicago  market,  then  the  reduction 
in  the  rate  on  the  imported  goods  would  cause  a  decrease 
of  revenues  to  the  railroads,  but  no  gain  to  consumers 
until  it  brought  the  foreign  product  below  the  domestic 
in  price.  The  railroads  must  lose,  therefore,  more  than 
the  consumers  gain;  or,  if  non-discriminating  rates 
would  enable  domestic  producers  to  realize  a  higher 
price,  then  the  railroads  and  domestic  producers  must 
lose  more  than  domestic  consumers  gain.  It  cannot 
be  said  that  the  railroads  are  compensated  for  their  loss 
by  carrying  more  glass,  for,  as  has  been  said,  it  cannot 
be  assumed  that  the  low  rates  charged  will  stimulate 
traffic  in  imported  glass,  any  more  than  correspondingly 
low  rates  would  stimulate  traffic  in  domestic  glass. 
Non-discriminating  rates,  with  exceptions  to  be  presently 
noted,1  at  least  if  they  can  be  secured  without  lessening 
the  stimulus  of  competition,  or  without  raising  average 
transportation  charges,  are  economically  more  desirable.2 

1  Chapter  V  (of  Part  III). 

2  A  secondary,  though  doubtless  in  practice  very  slight,  result  of  such  artificial 
stimulus  of  imports,  is  the  tendency  for  money  to  flow  abroad,  making  prices 
lower  here  and  higher  there.  As  a  consequence,  we  must  pay  somewhat  more 
for  what  we  buy  abroad,  while  we  receive  somewhat  less  for  what  we  sell.  In 
other  words,  the  rate  of  interchange  of  our  goods  for  foreign  goods  is  made  less 
favorable.  When  this  is  an  incidental,  as  well  as  a  relatively  minor,  consequence 
of  a  trade  profitable  to  us,  we  need  not  complain ;  but  it  deserves  to  be  mentioned 
as  an  additional  disadvantage  from  the  stimulating  of  an  uneconomical  trade. 


UNDESIRABLE  PLACE  DISCRIMINATION  107 


It  hardly  needs  to  be  added  that  the  reverse  system 
of  artificially  favoring  home  producers  is  also  uneco¬ 
nomical,  whether  it  takes  the  form  of  shutting  out  for¬ 
eign  goods  by  arbitrarily  high  rates,  or  of  subsidizing 
domestic  producers  by  rates  unduly  low.1  Such  a  policy 
of  discrimination  against  foreign  producers  is  most  likely 
to  be  followed  —  as  it  is,  in  fact,  followed  in  Germany 2 
—  where  railways  are  operated  by  government,  and 
where,  therefore,  railway  policy  becomes  a  matter  of 
politics  and  may  be  turned,  purposely,  to  protectionist 
ends. 

It  is  also  possible  to  use  publicly  managed  railroads 
to  derive  public  revenue  from  the  importation  of  goods 
not  produced  within  the  country,  i.e.  to  use  them  as  a 
means  of  collecting  import  duties  not  intended  to  be 
protective.  Or  railroads  can  be  used,  as  in  Germany,3 
to  raise  a  revenue  for  government  from  traffic  in  general. 
Obviously  such  a  policy  is  in  danger  of  being  carried 
too  far,  of  unduly  preventing  a  geographical  division  of 
labor  which  might  be  profitable,  and  so  of  preventing 
the  growth  of  that  fund  of  national  wealth  from  which 
all  taxes  must  be  drawn. 

It  is  apparent  that  the  relations  of  different  rates  to 
each  other  are  likely  to  be  different  when  all  or  nearly 
all  the  railroads  of  a  country  are  under  one  control,  e.g. 
government  control  as  in  Germany,  than  when  they  are 
operated  by  different  companies,  each  anxious  to  develop 
its  own  business  regardless  of  what  happens  to  the  rest. 
In  the  one  case,  discrimination  between  places  may  be 
reduced  to  a  minimum,  except  as  protectionist  influences 

1  Cf.,  however,  Chapter  V  (of  Part  III),  §  6. 

2  H.  R.  Meyer,  Government  Regulation  of  Railway  Rates,  New  York  (Mac¬ 
millan),  1 905,  p.  35. 

. 3  Ibid.,  pp.  72,  73. 


i°8  TRANSPORTATION  COSTS  OF  COMMERCE 

prevail.  In  the  other  case,  discrimination  between 
places  will  tend  towards  a  maximum,  except  as  it  is 
prevented  by  government  regulation.  Discriminations 
which,  if  not  effectively  prohibited  from  doing  so,  a  rail¬ 
road  might  feel  obliged  to  make  in  the  latter  case,  would 
often  be  discriminations  which  would  not  benefit  but 
which  would  tend  to  injure  the  country,  and  the  railroad 
systems  considered  all  together,  and  which,  therefore, 
if  the  same  interest  controlled  all  the  lines,  would  not 
be  made.  It  should  be  added  that  somewhat  higher 
rates  in  proportion  to  distance  carried ,  for  short-haul 
than  for  long-haul  traffic,  are  not  necessarily  discrimina¬ 
tions.  While  the  train  mileage  costs  increase  as  distance 
increases,  the  terminal  expenses  do  not.  If  a  proper 
amount  to  cover  terminal  expenses  is  added  to  a  hauling 
charge  made  in  proportion  to  distance,  the  total  will  be 
absolutely  less  but  greater  in  proportion  for  short  dis¬ 
tances  than  for  long.  It  will  not,  however,  on  that 
account  be  discrimination. 

§  4 

The  Uneconomy  of  the  “ Basing- point”  System 

It  has  been  argued  by  some  economists1  that  dis¬ 
crimination  between  places  may  be  economically  justifi¬ 
able  for  the  purpose  of  concentrating  the  movement  of 
freight  upon  “basing  points,”  thence  to  be  redistributed 
to  surrounding  towns.  Thus,  in  this  view,  it  might  be 
preferable  that  freight  should  be  carried  from  Boston 
or  New  York  to  Montgomery,  Ala.,  in  carload  or 
trainload  lots  and  thence  distributed  by  jobbers  to 
neighboring  towns  in  less  than  carload  lots,  rather  than 

1  For  example,  H.  R.  Meyer,  Government  Regulation  oj  Railway  Rates,  p.  298. 


UNDESIRABLE  PLACE  DISCRIMINATION  109 


that  shipments  should  go  direct  from  the  North  to  dealers 
in  these  other  towns  and,  therefore,  all  the  way  in  small 
consignments.  The  basing-point  system  of  the  South 
tended  to  the  former  result  by  making  rates  to  all  local 
points  equal  to  the  rate  to  the  “ basing  point”  plus  a 
local  rate  from  there  on  or  a  local  rate  back  to  an  inter¬ 
mediate  town.  Thus,  the  rate  from  New  York  to 
Troy,  Ala.,  was  made  by  taking  the  rate  to  Mont¬ 
gomery  and  adding  the  local  rate  (a  higher  rate  per 
mile)  between  Montgomery  and  Troy,1  even  though 
Troy  was  in  many  cases  the  nearer  point  and  goods  to 
Montgomery  were  to  a  considerable  extent  hauled  to 
that  place  through  Troy. 

The  error  in  the  argument  favoring  this  practice  lies 
in  the  assumption,  too  readily  arrived  at,  that,  without 
place  discrimination,  freight  must  move  toward  its 
destination  all  the  way  in  small  lots.  Nothing  could  be 
farther  from  the  truth.  It  needs  but  to  make  a  proper 
difference,  dependent  upon  difference  in  cost  of  carriage, 
in  wholesale  and  retail  rate,  such  as  a  difference  between 
the  rate  for  carload  as  distinguished  from  less  than  car¬ 
load  shipments,  to  secure  the  larger  shipments  presum¬ 
ably  to  the  extent  that  they  ought  to  be  large.  If  it 
really  costs  less  per  ton  to  carry  goods  in  carload  lots 
than  in  smaller  quantities,  then  the  railroads  should 
and  legally  may,  as  in  practice  they  usually  do,  make  a 
distinction  in  the  rate.  Where  the  advantage  of  having 
goods  move  in  smaller  quantities  and  more  frequently 
more  than  offsets  the  disadvantage  of  the  higher  cost, 
and  therefore  rate,  they  will  be  moved,  and  ought  to  be, 
in  less  than  carload  lots.  In  many  cases  it  may  be 
desirable  that  they  should  go  in  smaller  quantities 

1  See  Interstate  Commerce  Reports,  Vol.  VI,  pp.  3-35. 


no  TRANSPORTATION  COSTS  OF  COMMERCE 

direct  to  retail  dealers,  even  at  a  higher  rate,  rather  than 
be  burdened  with  two  sets  of  loading  and  unloading 
expenses.  But  where  there  is  no  such  advantage,  the 
tendency  will  be  for  the  goods  to  be  carried  in  larger 
shipments.  If  it  is  really  more  economical  for  goods  to 
be  carried  to  Montgomery  in  carload  lots  and  thence 
redistributed,  and  if  the  difference  in  the  carload  and 
less  than  carload  rates  is  an  accurate  measure  of  the 
difference  in  economy  or  cost,  then  the  small  neighbor¬ 
ing  dealer  will  find  that  he  can  more  cheaply  buy  his 
goods  in  Montgomery  or  some  other  large  near-by  city 
from  a  jobber  to  whom  they  have  come  by  carload  lot, 
than  he  can  get  them  from  Boston  or  New  York  in  smaller 
amounts.  The  consequence  will  be  that  the  large  jobber 
will  establish  himself  in  some  trade  center  from  which 
he  will  supply  the  surrounding  market. 

There  is  ample  evidence  from  experience,  that  the 
territorial  distribution  of  the  jobbing  trade  is  greatly 
dependent  on  the  relation  of  carload  to  less  than  carload 
rates.  In  one  of  the  cases  before  the  Interstate  Com¬ 
merce  Commission,  involving  rates  from  eastern  and 
middle  western  points  to  the  Pacific  Coast,1  a  considerable 
part  of  the  complaint  was  that  the  roads  made  too  great  a 
difference  in  rates  between  carload  and  less  than  carload 
shipments  and  that,  partly  in  consequence  of  this  dif¬ 
ference,2  goods  were  shipped  to  far  western  jobbers  in 
carload  lots,  to  be  by  them  redistributed,  whereas  they 
might  otherwise  have  been  sent  in  smaller  quantities 
from  St.  Louis  and  other  middle  western  jobbing  centers, 
direct  to  the  far  western  retailers.  In  this  case  it  was 

1  Interstate  Commerce  Reports,  Vol.  IX,  pp.  318-372. 

2  Although  partly,  doubtless,  because  of  lower  rates  to  the  coast  than  to  inland 
tar  western  points. 


UNDESIRABLE  PLACE  DISCRIMINATION  in 


alleged  that  the  difference  in  rates  on  shipments  of  the 
larger  and  smaller  amounts  was  excessive,  and  unduly 
and  unfairly  built  up  the  far  western  jobbing  centers  at 
the  expense  of  the  Middle  West.  Either  an  excessive 
difference  or  too  small  a  difference,  i.e.  any  difference 
other  than  that  properly  required  by  the  difference  in 
cost,  tends  to  make  freight  move  in  uneconomical  ways ; 
but  it  is  sufficiently  clear  that  the  extent  to  which  goods 
are  shipped  in  large  lots  to  distributing  centers  is  con¬ 
siderably  affected  by  comparative  carload  and  less  than 
carload  rates;  and  it  is  not  unreasonable  to  conclude 
that  a  difference  based  on  difference  in  cost  to  the  trans¬ 
portation  company  will  tend  to  bring  large-scale  ship¬ 
ment  to  whatever  extent  is  most  economical,  and  will 
tend  to  build  up  jobbing  centers  where  the  economic 
welfare  of  the  community  most  requires  them. 

It  does  not,  then,  require  arbitrary  discrimination 
between  places  to  bring  about  shipment  of  goods  in  the 
most  economical  way.  And  arbitrary  discrimination 
between  places,  so  far  as  it  brings  about  the  wholesale 
shipment  which  a  system  of  rates  based  upon  cost  would 
also  bring  about,  may  result,  just  because  it  is  a  purely 
arbitrary  rather  than  the  natural  method  of  attaining 
the  desired  end,  in  a  location  of  jobbers  in  a  city  favored 
by  the  rate  system,  when  they  would  otherwise,  perhaps, 
find  a  different  city  more  advantageous.  The  basing- 
point  system,  in  other  words,  may  be  a  comparatively 
artificial  selection  and  building  up  of  wholesale  or  job¬ 
bing  centers,  as  contrasted  with  a  possible  selection 
and  development  less  artificial  and  more  desirable. 
The  basing-point  system  may,  also,  because  of  its  arbi¬ 
trary  discrimination,  unduly  and  uneconomically  con¬ 
centrate  business  at  the  favored  point. 


ii2  TRANSPORTATION  COSTS  OF  COMMERCE 


§  5 

Dis crimination  in  Favor  of  Intrastate  Business ,  Resulting 
from  Orders  of  State  Commissions 

No  less  objectionable  than  discrimination  caused  by 
competitive  conditions  or  by  the  arbitrary  action  of 
transportation  company  managers,  is  discrimination 
brought  about,  as,  on  occasion,  it  has  been  brought 
about,  by  the  orders  of  state  railroad  commissions.  To 
illustrate,  the  Texas  Railroad  Commission  not  long 
since  ordered  rates  on  traffic  from  Dallas  and  Houston 
to  various  other  Texas  points,  so  low  as  to  put  Shreve¬ 
port,  La.,  at  a  disadvantage  in  seeking  to  market  goods, 
competitively  with  Dallas  and  Houston,  in  these  other 
Texas  centers. 

Such  discrimination  is  partly  analogous  to  a  protective 
tariff  (around  the  borders  of  Texas).  It  would  tend 
somewhat  to  prevent  the  bringing  of  goods  into  Texas 
from  points  outside  of  that  state.  But  it  differs  from 
protection  because  it  operates  not  alone  and  not  inten¬ 
tionally  through  high  rates  on  imported  goods.  A  state 
commission,  indeed,  would  have  no  shadow  of  power  to 
order  an  increase  of  rates  on  interstate  traffic.  The 
discrimination  in  question  operates  rather  through  the 
enforced  reduction  of  intrastate  rates.  There  is  here, 
therefore,  some  resemblance  to  a  bounty  or  subsidy  on 
internal  trade.  Nothing  is  done,  directly,  to  prevent 
importation.  But  home  producers,  or  jobbers,  or  both, 
are  favored  by  the  low  intrastate  rates.  If  the  state 
were  to  compensate  the  railroads  operating  within  it, 
for  any  loss  so  caused,  the  burden  of  the  lower  rates 
would  fall  on  taxpayers,  and  the  analogy  with  a  bounty 


UNDESIRABLE  PLACE  DISCRIMINATION  113 


or  subsidy  would  be  complete.1  We  should  then  cer¬ 
tainly  contend  that  even  the  Texans  themselves,  as  a 
whole,  gained  nothing  from  the  discrimination.  Every 
dollar  thus  saved  by  a  Texas  consumer,  through  patroniz¬ 
ing  a  home  producer  or  jobber  favored  by  the  low  rates, 
would  be  a  dollar  filched  from  the  Texas  taxpayers. 
And  to  the  extent  that  an  outside  producer  could  sell, 
if  not  discriminated  against,  more  cheaply,  the  taxpayers 
must  lose  by  such  discrimination  more  than  the  con¬ 
sumer  gains.  Furthermore,  Texas  industry  would  be 
diverted  out  of  its  most  profitable  channels,  artificially, 
and  at  the  expense  of  Texas  taxpayers. 

There  is  not,  of  course,  in  practice,  any  such  compen¬ 
sation  made  to  railroad  security  owners,  by  a  state,  for 
low  intrastate  rates.  But  our  conclusions  as  to  the 
unwisdom  of  the  policy  are  not,  on  that  account,  very 
different.  The  loss  resulting  from  the  reduced  rates,  if 
taxpayers  are  not  to  bear  it,  must  fall  either  upon  the 
owners  of  railroad  securities,  who  thus  get  smaller  re¬ 
turns,  or  upon  other  shippers  and  consumers  who  have  to 
pay  higher  rates  than  would  else  be  required.  These 
other  shippers  and  consumers  may  be,  to  a  large  extent, 
persons  in  Texas  who  ship  goods  to  and  get  goods  from 
other  states.  Shippers  and  consumers  in  these  other 
states  may  likewise  suffer.  If  intrastate  rates  may  be 
made  too  low  to  yield  a  fair  profit,  the  opportunities  for 
enforced  reduction  of  high  interstate  rates  become  less 
favorable.  So  far  as  interstate  rates  might  thus  remain 
higher  than  they  would  otherwise  be,  they  must  operate, 
like  a  protective  tariff,  to  prevent  trade  profitable  both 
to  the  rate-reducing  state  and  to  the  other  states.  It 
is  difficult  to  believe  that  a  state  can  gain  any  permanent 

1  See  Part  II,  Chapter  VII  and  §§  2,  3,  and  4  of  Chapter  VIII. 

PART  m  —  I 


1 14  TRANSPORTATION  COSTS  OF  COMMERCE 

benefit  from  the  enforcement  of  discriminatory  and  un¬ 
duly  low  rates  on  intrastate  business.  If  it  secures  a 
temporary  gain  at  the  expense  of  inadequate  returns  to 
railroad  investors,  the  building  of  railroad  mileage  within 
the  state  will  be  discouraged.  If  the  low  intrastate 
rates  involve  higher  interstate  rates,  they  act  like  a  pro¬ 
tective  tariff  in  restricting  profitable  trade  and  like  a 
bounty  in  encouraging  unprofitable  trade;  though  the 
burden  of  this  “bounty’'  falls  upon  those  who  still  en¬ 
gage  in  interstate  business,  rather  than  upon  the  body 
of  taxpayers.  And  neighbor  states  are  hardly  likely  to 
allow  the  railroads  to  recoup  any  losses  suffered,  by 
charging  high  intrastate  rates  within  their  borders. 

A  state  commission  may  properly  prevent  the  charg¬ 
ing  of  exorbitant  or  monopoly  rates  on  intrastate  busi¬ 
ness,  and  throw  upon  the  Federal  body  the  responsibility 
for  discrimination  against  interstate  business,  resulting 
from  unduly  high  rates  allowed  on  such  business.  But 
it  should  not,  even  for  the  welfare  of  the  state  itself, 
enforce  discriminating  and  unfairly  low  intrastate  rates. 
Nor  can  such  a  policy  be  allowed  by  the  Federal  govern¬ 
ment,  even  if  individual  states  short-sightedly  favor  its 
application  within  their  boundaries. 

In  the  Shreveport  case,  complaint  was  made  to  the 
Interstate  Commerce  Commission  against  the  discrimi¬ 
nation  to  which  Shreveport  was  subjected.  The  Inter¬ 
state  Commission  ordered  that  the  discrimination  should 
cease.  It  fixed,  to  be  sure,  maximum  rates,  thus  cor¬ 
recting  the  discrimination,  in  part,  by  reducing  inter¬ 
state  rates.  But  it  allowed  the  discrimination  to  be 
partly  corrected  by  the  raising  of  intrastate  rates,  from 
Dallas  and  Houston  to  other  Texas  points.  Appeal  was 
therefore  made  to  the  Commerce  Court  and  from  it  to 


UNDESIRABLE  PLACE  DISCRIMINATION  115 


the  Supreme  Court.1  The  ruling  of  the  Interstate  Com¬ 
mission  was  objected  to  as  beyond  its  authority,  on  the 
ground  that  this  Commission  has  no  authority  over 
rates  on  traffic  wholly  within  a  state  and  that  some  of 
the  intrastate  rates  in  question  had  been  fixed  by  the 
Railroad  Commission  of  Texas  below  the  maximum 
rates  prescribed  by  the  Interstate  Commerce  Commis¬ 
sion  for  interstate  traffic.  The  Supreme  Court,  in  hand¬ 
ing  down  a  decision  favorable  to  the  Federal  regulating 
body,  declared  that  Congress  has  the  right  to  prevent 
such  discrimination  against  interstate  commerce  as  would 
have  resulted  from  the  uncorrected  Texas  rates,  and,  in 
general,  that  Congress  has  authority  to  prevent  any  use 
of  an  instrumentality  of  interstate  commerce  (e.g.  a 
railroad)  which  would  discriminate  against  such  com¬ 
merce.  The  power  to  deal  with  the  relation  of  intrastate 
and  interstate  rates,  as  a  relation ,  the  court  asserted  to 
lie  wholly  with  Congress.2 


Discrimination  by  a  Transportation  Company  in  Favor  of 

Traffic  Moving  a  Long  Distance  over  its  Own  Lines 

Discrimination  may  also  result  from  the  desire  of  a 
railroad  (or  navigation  company)  to  give  preference  to 
traffic  moving  solely  or  mainly  over  its  own  lines  as 
against  traffic  using  chiefly  the  lines  of  another  com¬ 
pany.  Thus,  goods  may  be  produced  at  some  point  or 

1  Houston  and  Texas  Railway  v.  United  States,  234  U.  S.,  342. 

2  The  decision  in  the  Minnesota  Rate  case  (230  U.  S.,  352)  is  not  incon¬ 
sistent  with  this.  In  that  case  the  court  upheld  state-made  rates  which  were 
asserted  to  involve  discrimination  against  interstate  commerce.  But  in  that 
case,  as  the  court  took  occasion  to  point  out,  no  application  of  Federal  regula¬ 
tion  through  a  decision  of  the  Interstate  Commerce  Commission  was  before  it 
for  review. 


n6  TRANSPORTATION  COSTS  OF  COMMERCE 

points  on  a  railroad  and  be  marketable  in  two  or  more 
directions ;  and  it  may  be  that  if  the  goods  are  sent  in 
one  of  these  directions  they  will  soon  leave  the  rails  of 
the  originating  line  to  complete  the  journey  over  another 
road,  while  if  they  are  sent  to  a  market  in  a  different 
direction,  the  originating  road  can  carry  them  most  or 
all  of  the  way.  Under  such  circumstances,  the  originat¬ 
ing  road  may  be  tempted  to  charge  comparatively  high 
rates  per  mile  for  its  part  of  the  joint  haul  made  by 
small  use  of  its  own  rails,  while  charging  comparatively 

low  rates  per  mile  on  traffic  going  the  long  distance  over 
its  own  lines. 

In  a  case  decided  by  the  Interstate  Commerce  Com¬ 
mission  in  1900,  it  appeared  that  the  Louisville  and 
Nashville  Railroad  was  engaging  in  this  practice  in 
regard  to  naval  stores  and  cotton  shipped  from  points 
on  its  Pensacola  and  Atlantic  division  in  Florida.  These 
goods,  if  shipped  eastward,  e.g.  to  Savannah,  soon  left 
the  lines  of  the  Louisville  and  Nashville  road,  reaching 
Savannah  over  other  lines;  while  if  they  were  shipped 
westward,  some  of  them  would  eventually  be  carried 
hundreds  of  miles  over  its  own  rails.  The  eastward 
rates,  accordingly,  were  kept  comparatively  high  and 
the  westward  rates  made  comparatively  low,  largely  in 
order  to  discourage  eastward  and  encourage  westward 
shipments.  Such  a  policy  involves  discrimination  be¬ 
tween  the  markets  to  which  the  goods  may  be  sent,  — 
in  the  case  mentioned,  it  involved  discrimination  against 
Savannah ;  it  may  cause  traffic  to  flow  in  an  uneco¬ 
nomical  direction;  and  it  may  compel  the  market 
(Savannah,  in  this  case)  on  the  lines  of  the  connecting 
railroad,  to  draw  supplies  from  a  relatively  uneconomical 

1  Interstate  Commerce  Reports,  Vol.  VIII,  pp.  376-408. 


UNDESIRABLE  PLACE  DISCRIMINATION  117 


source.  Nor  do  the  transportation  companies  them¬ 
selves,  as  a  whole,  benefit  from  such  a  policy,  since  the 
traffic  which  any  one  company  gains  by  thus  preferring 
it  own  lines,  another  company  loses ;  and  the  policy,  if 
allowed,  can  be  practiced  independently  and  in  retalia¬ 
tion  by  all  the  companies.  The  Interstate  Commerce 
Commission,  in  the  case  above  cited,  declared  the  dis¬ 
crimination  practiced  to  be  unreasonable,  and  ordered 
a  readjustment  which  partially,  at  least,  corrected  the 
evil  complained  of. 

A  railroad  may  likewise  endeavor,  by  means  of  dis¬ 
criminating  rates,  to  supply  cities  on  its  own  lines  mainly 
with  goods  which  it  carries  a  long  distance  over  its  own 
rails,  rather  than  with  goods  produced  at  other  points, 
which  must  be  delivered  to  it  by  connections  and  which 
it  can  carry  but  a  few  miles.  This  species  of  discrimina¬ 
tion,  also,  involves  economic  waste  and  has  been  dis¬ 
approved  of  by  the  Interstate  Commerce  Commission.1 

§  7 

Summary 

Discrimination  between  places  we  have  seen  to  be 
chiefly  due  to  competition.  This  competition  may  be 
competition  of  routes,  competition  of  directions,  or  com¬ 
petition  of  locations.  It  may  even  be  competition  with 
local  self-sufficiency. 

Competition  between  two  or  more  railroad  companies, 
which  causes  discrimination  by  each  in  favor  of  com¬ 
petitive  and  against  intermediate  traffic,  involves  waste. 
The  railroad  plants,  considered  altogether,  are  probably 

1  Interstate  Commerce  Reports,  Vol.  VI,  pp.  488-519  (see,  especially,  pp. 

515,  516). 


n8  TRANSPORTATION  COSTS  OF  COMMERCE 

not  more  fully  utilized  than  if  rates  were  no  higher  on 
the  average  and  more  equal,  though  one  or  more  plants 
may  be  more  fully  utilized  and  the  others,  or  other,  less 
so.  Industry  is  less  apt  to  develop  in  those  places  where 
the  natural  advantages  favor  it.  Rather  is  its  location 
partly  determined  by  the  fact  of  railroad  competition 
at  some  points  and  not  at  others.  Furthermore,  goods 
may  frequently  be  carried  by  rail  a  longer  distance, 
when  a  more  economical  location  of  industries  would 
result  in  their  being  carried  a  shorter  distance. 

This  kind  of  discrimination  between  places  has  been 
practiced  by  American  railroads,  in  favor  of  import 
traffic,  as  against  carriage  of  goods  from  an  American 
center  of  production,  to  the  same  American  consuming 
center.  The  consequent  tendency  is  for  American  labor 
and  capital  to  be  kept  out  of  or  driven  out  of  a  line 
which  they  would  otherwise  naturally  follow.  Goods 
are  imported  .from  abroad  which  might  be  produced 
with  less  labor  cost  at  home.  Discrimination  against 
imported  goods  is  more  likely  to  be  practiced  by  a  gov¬ 
ernment  railroad  system  influenced  by  protectionist 
motives.  It  is  no  less  uneconomical  than  the  reverse 
practice.  Discrimination  in  favor  of  imported  goods 
tends  to  drive  a  country’s  industry  out  of  channels 
which  it  might  profitably  follow.  Discrimination  against 
imported  goods  tends  to  guide  a  country’s  industry  into 
channels  which  are  not  profitable. 

The  basing-point  system  has  sometimes  been  defended 
as  a  kind  of  discrimination  between  places,  which  con¬ 
duces  to  economy  of  transportation  by  favoring  large 
shipments.  But  it  appears  that  an  economically  justi¬ 
fiable  difference  in  rates  on  carload  and  less  than  car¬ 
load  freight,  based  on  actual  difference  in  cost  of  carry- 


UNDESIRABLE  PLACE  DISCRIMINATION  119 


ing,  is  likely  to  secure  large-scale  shipment  so  far  as  it 
should  be  secured.  And,  on  the  other  hand,  the  basing- 
point  system,  like  other  discrimination  between  cities, 
may  tend  to  develop  business  in  a  favored  city  at  the 
expense  of  some  other,  better  situated  city,  and  beyond 
what  true  national  economy  would  justify. 

Unduly  low  intrastate  rates  made  by  a  state  com¬ 
mission,  for  the  encouragement  of  shippers  within  the 
state  as  against  competitors  from  outside,  are  adverse 
to  the  general  interest  of  the  American  public  and  are 
practically  certain  to  injure  even  the  state  which  en¬ 
deavors  to  enforce  them.  Federal  power,  operating 
through  the  Interstate  Commerce  Commission,  is,  how¬ 
ever,  supreme  where  interstate  business  is  discriminated 
against  and  can  put  a  stop  to  such  discrimination. 

Discrimination  by  a  transportation  company  against 
goods  coming  from  or  going  to  points  on  other  lines,  in 
order  to  force  goods  to  go  long  distances  over  its  own  lines, 
also  involves  economic  waste. 


CHAPTER  V 


Economically  Defensible  Discrimination  among 

Places 


Discrimination  among  Places ,  by  a  Roundabout  Line 

In  the  last  chapter  we  saw  that  discrimination  among 
places,  caused  by  competition  at  some  places  and  not  at 
others,  and  practiced  on  all  the  lines  or  routes  engaged  in 
this  competition,  involves  economic  waste.  But  there 
are  situations  in  which  discrimination  by  a  railroad  in 
favor  of  junction  points,  and  against  intermediate  points, 
is  not  uneconomical.  Such  a  situation  may  exist  when 
one  of  the  lines  connecting  two  junction  points  is  appre¬ 
ciably  more  roundabout  than  the  other  or  others.  We 
saw,  in  a  previous  chapter,1  that  goods  might  more 
profitably  be  carried  by  a  relatively  roundabout  line  in 
three  cases  :  first,  when  traffic  is  in  excess  of  the  facilities 
of  more  direct  lines  and  the  surplus  can  be  carried  by  the 
roundabout  one,  this  may  be  better  than  to  invest  addi¬ 
tional  capital  in  direct  lines ;  second,  when  a  new  line 
or  an  additional  line  must  be  constructed  for  traffic 
between  two  points,  a  roundabout  line  may  sometimes 
be  preferable  and  able  to  carry  the  traffic  more  cheaply, 
by  virtue  of  securing  more  intermediate  traffic  to  help 
pay  general  expenses,  interest,  and  profits ;  third,  when 
facilities  are  in  excess  of  traffic  and  must  be  in  part 

1  Chapter  II  (of  Part  III),  §  2. 


120 


DEFENSIBLE  PLACE  DISCRIMINATION  121 


abandoned,  it  may  be  desirable  to  continue  operating  a 
relatively  roundabout  line  between  two  points  if  inter¬ 
mediate  business  pays  part  of  its  expenses  and  profits 
and  enables  it  to  carry  the  through  business  for  the 
lowest  rates.  But  if  a  relatively  devious  line,  A  BCD 
(see  figure  13),  is  to  carry  traffic  between  two  points,  A 

a*- - ■  xD 

\  V 


Figure  13 


and  D,  which  are  or  can  be  served  by  a  more  direct  road, 
the  roundabout  line  must  be  permitted  to  make  rates  at 
least  as  low  as  those  the  direct  line  does  or  would  make. 
If  the  direct  road  is  there,  the  roundabout  road,  A  BCD, 
will  have  to  make  an  equally  low  rate  between  A  and  D, 
to  get  a  satisfactory  share  of  the  traffic.  Furthermore, 
the  cities  A  and  D  may  claim,  with  reason,  that  their 
situation  with  respect  to  each  other  entitles  them  to  a 
rate  on  traffic  between  them,  based  on  the  shortest 
distance  connection;  and  that  even  if  a  short  line  did 
not  exist,  the  rate  between  them  should  not  be  much,  if 
any,  higher  than  would  yield  a  fair  profit  on  the  capital 
required  for  such  a  direct  line.1  A  higher  rate  would 

1  This  does  not  mean  that  the  longer  distance  points  can  always  reasonably 
expect  low  rates  on  traffic  between  them,  for  such  traffic  may  sometimes  be  so 
light  that  a  direct  road  could  not  be  made  to  pay  or  could  be  made  to  pay  only 
by  charging  very  high  rates.  A  roundabout  line  may  conceivably  be  able  to 
charge  rates  no  higher,  perhaps  lower,  and  still  not  discriminate  against  inter¬ 
mediate  points.  If  so,  discrimination  by  such  a  line  against  intermediate 
points  would  not  be  justifiable. 


122  TRANSPORTATION  COSTS  OF  COMMERCE 

be  exorbitant  and  would  subject  A  and  D  to  unreason¬ 
able  disadvantage.  A  higher  rate  would  not  be  normal 
and  could  only  continue  if  no  new  company  dared  enter 
the  business.  For  a  normal  rate  is  one  which  yields  the 
average  return  on  the  capital  necessary  for  the  service. 
The  roundabout  line  A  BCD  has  been  made  long  in 
order  that  it  might  serve  B  and  C.  Its  roundaboutness  is 
largely  for  their  benefit.  The  extra  cost  incurred  was 
incurred  entirely  for  the  sake  of  intermediate  traffic,  e.g . 
A  to  B,  A  to  C,  B  to  C,  etc.  The  burden  of  this  cost 
cannot,  except  arbitrarily  or  by  favoritism,  be  imposed 
upon  the  through  traffic  between  A  and  D. 

In  such  a  case  as  we  have  under  discussion,  it  may  be 
economically  desirable  that  the  long  line  should  get  at 
least  a  share  of  the  business,  rather  than  that  it  should 
refuse  to  compete,  and  should,  therefore,  for  one  possibil¬ 
ity,  encourage  additional  track  building  by  a  more  direct 
road.  Also,  it  may  be  necessary  and  right  that  the  long¬ 
distance  business,  A  to  D  and  D  to  A ,  should  not  have  to 
pay  high  rates.  Yet  the  indirect  line  probably  cannot, 
with  reason,  be  expected  to  reduce  all  of  its  intermediate 
rates  to  an  equally  low  level.  From  A  to  C  over  the 
roundabout  line  is  farther  than  from  A  to  D  over  a 
direct  line.  To  compel  the  road  A  BCD  to  charge  as 
little  or  less  from  A  to  C  as  should  be  charged  and  as  it 
probably  has  to  charge  from  A  to  D,  may  deprive  it  of 
a  fair  return.  Such  a  policy,  consistently  applied  over 
a  long  period  of  years,  would  tend,  somewhat,  to  prevent 
the  building  of  roundabout  lives  having  to  rely  upon  long¬ 
distance  traffic  for  part  of  their  returns.  It  would  tend, 
therefore,  to  deprive  intermediate  points  not  in  a  direct 
line  between  two  given  points,  of  railroad  service.  To 
follow  the  policy  of  letting  the  roundabout  line  dis- 


DEFENSIBLE  PLACE  DISCRIMINATION  123 


criminate  against  the  intermediate  points,  may  therefore 
make  the  discrimination  against  them  really  less  than  it 
otherwise  would  be.  If  such  discrimination  is  prohibited, 
it  may  well  happen  that  these  intermediate  points  will 
either  have  no  service,  or  will  have  to  pay  in  rates  the  entire 
expenses  and  profits  of  a  road ;  while  A  and  D  continue  to 
get  rates  at  least  as  low  as  a  direct  line  can  afford  to  charge, 
for  if  the  reasonable  rate  over  the  direct  line  is  not  made 
voluntarily,  it  may  be  forced  by  regulation. 

On  the  other  hand,  the  extent  to  which  this  discrimina¬ 
tion  may  properly  be  carried  is  not  without  limit.  The 
longer  line  should  not  be  allowed  to  charge  rates  on  its 
intermediate  traffic,  where  it  has  a  monopoly,  higher 
than  would  yield  a  fair  profit  on  capital  invested,  from 
that  traffic  alone.  Neither  should  it  be  allowed  to  engage 
in  competition  for  the  longer  distance  traffic  between  A 
and  D,  even  if  it  were  foolish  enough  to  attempt  to  or 
would  do  so  as  a  matter  of  temporary  policy,  at  rates 
which  would  pay  less  than  the  special  additional  cost 
(train  mileage  and  terminal  expenses)  of  carrying  this 
longer  distance  traffic.  If  a  direct  line  can  afford  to 
carry  the  traffic  for  rates  less  than  would  yield  the  round¬ 
about  road  some  slight  return  above  this  cost,  the  direct 
line  may  properly  be  allowed  to  have  it. 

But  we  have  seen  that  when  competition  between  two 
or  more  lines  causes  discrimination  against  intermediate 
points  on  all  such  lines,  there  is  a  tendency  towards 
uneconomical  application  of  the  community’s  labor 
force.1  Even  though  the  direct  line  taps  less  inter¬ 
mediate  traffic  than  the  other,  it  is  almost  certain  that 
it  will  tap  some,  e.g.  A  to  E.  While  the  reasons  given 
may  sometimes  justify  a  limited  amount  of  discrimina- 

1  Chapter  IV  (of  Part  III),  §  2. 


124  TRANSPORTATION  COSTS  OF  COMMERCE 


tion  in  favor  of  A  and  D  traffic  as  compared  with  inter¬ 
mediate  traffic  on  a  roundabout  line,  they  do  not  justify 
on  grounds  of  economy,  discrimination  in  favor  of  A  and 
D  traffic  as  compared  with  intermediate  traffic,  A  to  E, 
etc.,  by  a  direct  line.1  A  and  D  may  reasonably  urge 
that  they  are  entitled  to  a  rate  between  them  which  can 
be  afforded,  without  discrimination,  by  a  direct  line,  and 
that  an  indirect  line,  if  this  A  and  D  traffic  can  be  more 
economically  carried  by  it,  can  properly  make  such  a  rate. 
But  A  and  D  cannot  reasonably  urge  that  they  are  entitled 
to  a  low  rate  on  the  direct  line  at  the  expense  of  E. 

We  conclude,  then,  that  the  rates  on  intermediate 
traffic  on  neither  line  should  exceed  a  fair  profit  on  the 
requisite  capital  for  taking  this  traffic;  that  the  rates 
on  the  competitive  traffic  should  not  exceed  what  would 
give,  along  with  the  charges  on  intermediate  traffic,  a  fair 
profit  on  the  cost  of  a  direct  line ;  and  that  discrimination 
on  a  direct  line  is  not  economically  justifiable.  How  can 
the  government  or  a  government  regulating  body  make  its 
rulings  consistent  with  all  these  principles,  while  yet  not 
preventing  the  carriage  of  goods,  in  each  case,  by  the 
more  (or  the  most)  economical  line  ?  The  conclusion  at 
which  we  shall  arrive  is  substantially  the  same  (though 
it  will  be  stated  more  completely)  as  was  arrived  at  in 
a  previous  chapter.2  The  direct  line  may,  in  most 
cases,  properly  be  prohibited  from  discriminating*  at 
all,  or  at  least  from  discriminating  appreciably,  against 
intermediate  traffic.  But  such  prohibition  will  make  it 
impossible  for  the  direct  line  to  carry  the  A  to  D  and  D 
to  A  traffic  for  the  bare  additional  cost  to  it  of  carrying 
this  traffic,  since  this  traffic  must  then  pay  a  good  share 

1  See,  however,  §  5  of  this  Chapter  (V  of  Part  III). 

*  Chapter  II  (of  Part  III),  §  2. 


DEFENSIBLE  PLACE  DISCRIMINATION  125 


of  its  general  expenses,  interest,  and  profits.  To  let  the 
roundabout  line  carry  this  through  traffic  for  the  bare 
additional  cost  of  carrying,  while  forbidding  any  discrim¬ 
ination  on  the  direct  road,  would  frequently  give  the 
roundabout  line  an  undue  advantage  and  would  be  likely 
to  result  in  its  taking  most  or  all  of  this  through  traffic, 
whether  it  was  the  more  economical  route  or  not .  To  abso¬ 
lutely  forbid  discrimination  by  the  roundabout  line 
would  be  likely,  as  we  have  seen,1  to  prevent  that  line 
from  carrying  any  of  the  through  traffic,  whether  it  was 
economically  desirable  that  it  should  carry  any  of  this 
traffic  or  not.  If  it  is  desirable  that  the  direct  line  should 
not  discriminate  at  all,  some  limit  must  frequently  be 
placed  to  the  discrimination  allowed  on  the  longer  line, 
beyond  requiring  that  it  shall  not  carry  competitive 
traffic  at  a  loss  and  that  it  shall  not  charge  exhorbitant 
rates  on  non-competitive  traffic.  The  aim  should  be  to 
leave  the  two  (or  more)  railroads,  after  regulation  of 
discrimination,  in  the  same  relative  positions  as  before, 
so  that  each  road  would  still  be  able  to  take,  in  competi¬ 
tion,  the  business  which  it  was  most  fitted,  economically, 
to  take.  Properly  to  decide,  in  each  case,  what  relation 
of  rates  may  be  allowed,  would  be  a  task  of  extreme 
difficulty.  Only  approximately  satisfactory  results  can 
be  expected.  But  it  is  believed  that  to  have  some  control 
of  this  sort  is  better  than  to  suffer  all  the  wastes  and 
inequalities  of  unregulated  competition.  If  the  general 
rule  of  the  4th  section  of  the  Interstate  Commerce  Law 
is  applied  to  the  direct  road,  viz.,  that  no  greater  charge 
shall  be  made  for  a  shorter  haul  than  for  a  longer  one, 
over  the  same  line  in  the  same  direction,  when  the 
shorter  haul  is  included  in  the  longer,  then  a  per  cent 


1  Ibid. 


126  TRANSPORTATION  COSTS  OF  COMMERCE 

deviation  from  this  rule  should,  in  many  cases,  be  allowed 
to  the  longer  line.  As  a  matter  of  fact,  the  4th  section 
of  the  Interstate  Commerce  Law,  in  its  amended  form, 
gives  the  Interstate  Commerce  Commission  the  power 
to  prescribe,  from  time  to  time,  the  extent  to  which 
common  carriers,  subject  to  its  jurisdiction,  may  be  re¬ 
lieved  from  the  above-stated  requirement.  The  Com¬ 
mission,  in  the  exercise  of  the  discretion  thus  given  it  by 
law,  should,  it  is  thought,  decide  each  case  arising,  with 
due  reference  to  the  principles  above  set  forth,  and,  in 
fact,  does  decide  cases  in  the  light  of  some  (though  not, 
apparently,  all)  of  these  principles.1 

The  carriage  of  a  part  of  import  and  export  traffic  by 
the  more  indirect  routes  involves  discrimination  in  favor 
of  this  traffic  by  those  routes,  as  compared  with  the  rates 
charged  upon  intermediate  traffic,  including  strictly 
domestic  traffic.  The  more  indirect  lines  must  discrim¬ 
inate  if  they  would  meet  the  competition  of  the  more 
direct.  If  they  do  not  meet  this  competition,  the  direct 
lines  may  be  encouraged  to  add  to  their  plants,  when  the 
truest  economy  for  the  community  would  require  that 
some  of  the  traffic  be  carried  on  roundabout  lines.  On 
exported  grain,  for  example,  the  rate  to  Liverpool  via 
New  Orleans  or  Galveston  cannot  be  higher  than  by  way 
of  New  York,  and  if  the  water  rate  is  higher  from  New 
Orleans  to  Liverpool  than  from  New  York,  then  the  rail 
rate  to  New  Orleans  must  be  correspondingly  lower  than 
to  New  York.  Similarly,  on  imported  goods  the  rate 
over  the  longer  routes  must  be  as  low  as  over  a  shorter, 
if  any  goods  are  to  be  carried  by  the  longer  routes.  But 
the  intermediate  rates,  including  strictly  domestic  rates, 
cannot  usually  be  made  correspondingly  low.  A  certain 

1  See  Twenty-fifth  Annual  Report  of  the  Interstate  Commerce  Commission, 
1911,  pp.  22-26. 


DEFENSIBLE  PLACE  DISCRIMINATION  127 


amount  of  discrimination  on  the  longer  lines  should  some¬ 
times,  therefore,  according  to  the  principles  which  have 
been  here  elaborated,  be  allowed.  Providing  the  discrim¬ 
ination  allowed  is  not  so  much  that  the  through  traffic 
is  favored  over  domestic  traffic,  by  the  more  nearly  direct 
lines,  it  is  not  uneconomical  and  does  not  involve  a  turn¬ 
ing  of  the  country’s  labor  out  of  its  natural  channels. 
For  the  foreign  producers  would  have,  in  any  case,  and 
ought  to  have,  the  advantage  of  sending  goods  to  their 
American  market  by  the  most  direct  route,  and  American 
consumers  should  have  the  advantage  of  getting  foreign 
goods  at  fair  rates  over  the  shortest  possible  route.  If 
roundabout  lines  are  able,  by  carrying  imported  goods  at 
the  low  rates  which  this  competition  of  direct  lines  com¬ 
pels,  to  secure  returns  which  make  it  possible  for  the  long 
lines  to  serve  intermediate  points  more  cheaply  than  they 
otherwise  could,  or  to  serve  intermediate  points  where 
railroads  could  not  otherwise  be  built,  it  cannot  be  said 
that,  on  the  whole,  foreign  producers  are  thereby  given 
artificial  advantages  over  domestic.  Only  when  the  com¬ 
petition  for  the  longer  distance  traffic  makes  the  rate  so 
low  compared  to  domestic  traffic,  as  to  subject  domestic 
producers  to  discrimination  even  on  the  direct  lines,  can 
we  confidently  assert  that  the  discrimination,  by  a  round¬ 
about  line  not  completely  utilized  for  intermediate  or 
strictly  domestic  traffic,  is  uneconomical. 

§  2 

Discrimination  by  the  Longer  or  Longest  Line ,  when  there 
is  Competition  of  Directions  or  of  Locations 

The  principle  that,  under  certain  circumstances,  it  is 
economically  desirable  for  a  longer  line  to  carry  goods  of 


128  TRANSPORTATION  COSTS  OF  COMMERCE 


certain  kinds,  rather  than  a  shorter  line,  and  that  the 
longer  line  may  properly  be  allowed  to  discriminate  to 
a  certain  degree  in  order  to  do  so,  applies  not  only  when 
there  is  competition  of  routes,  but  also  when  there  is 
competition  of  directions  and  competition  of  locations. 
Suppose,  for  example,  the  railroads  AB  and  AC  leading 
to  a  common  market  A  from  the  divergent  lumber-pro¬ 
ducing  centers  B  and  C,  the  road  AC  being  the  longer. 
(See  figure  14.)  Suppose,  also,  that  the  labor  cost  of 


Figure  14 


producing  lumber  at  C  is  as  great  as  at  B.  Suppose 
lastly,  that  there  is  competition  between  the  roads,  each 
to  develop  the  lumber  business  on  its  line,  i.e.  competition 
of  locations ;  or  else  that  there  is,  for  the  lumber-produc¬ 
ing  center  on  each  road,  the  option  of  shipping  by  another 
or  other  roads  to  a  different  market,  so  that  there  is  a 
real  competition  of  directions.  Under  such  circum¬ 
stances,  it  will  sometimes  be  more  economical  that  A 
should  receive  part  of  its  lumber  from  C  over  the  longer 
line.  It  may  be  that  the  longer  line  is  able  to  pay  much 
of  its  general  expenses  and  profits  from  local  business, 


DEFENSIBLE  PLACE  DISCRIMINATION  129 


e.g.  C  to  D.  Yet  the  through  traffic,  C  to  A ,  will  perhaps 
pay  something  more  than  the  mere  extra  cost  of  carrying, 
and  so  will  be  worth  seeking.  To  adopt  the  principle 
that  A  should  be  served  entirely  from  the  shorter  distance 
source,  B,  is  to  insist  that,  if  necessary,  a  new  line  from 
B  to  A  should  be  constructed  to  carry  the  B  lumber  to  A , 
even  though  this  traffic  alone  would  have  to  pay  a  much 
larger  proportion  of  general  expenses,  fixed  charges,  and 
profits  than  the  through  traffic  on  the  road  CA.  It 
might  very  well  be  more  economical  that  the  longer  line, 
CA,  which  has  intermediate  traffic  from  C  to  D,  etc.,  per¬ 
haps  more  than  the  other  road,  and  which  may,  therefore, 
be  able  to  take  the  C  to  A  business  for  a  little  more  than 
the  mere  terminal  and  train  mileage  expenses  incident  to 
it,  should  mainly  carry  the  required  lumber  to  A.  An 
exactly  parallel  argument  would  show  that  it  might  be 
preferable  for  the  road  CA  to  carry  lumber  from  C  to  A , 
than  for  a  shorter  road,  having  less  intermediate  traffic, 
to  be  constructed  with  sufficient  trackage  to  carry  all 
this  C  lumber  to  some  other  and  nearer  market  where  it 
would  bring  no  higher  price. 

If,  however,  we  admit  these  points,  we  are  compelled 
to  admit  that  discrimination  on  the  longer  roads  —  but 
not  on  all  the  roads  —  may  be  justified.  The  line  CA 
must  meet  at  A  the  competition  of  an  actual  or  possible 
shorter  railroad.  A  is  entitled  to  a  price  for  lumber 
based  on  a  rate  which  such  a  road  could  give.  C  may  be 
entitled  to  a  profit  based  on  conditions  in  a  nearer  market 
and  over  another  actual  or  possible  railroad.  The  road 
CA  must,  perhaps,  make  a  low  rate  on  through  business 
or  lose  the  business.  Yet  it  cannot  afford  to  make 
equally  low  rates  on  its  intermediate  traffic,  such  as 
that  from  C  to  D.  Nevertheless,  the  point  D  may  be, 


PART  III  —  K 


130  TRANSPORTATION  COSTS  OF  COMMERCE 

on  the  whole,  helped  rather  than  hurt  by  the  possibility 
of  some  other  traffic  for  the  railroad  ^4C. 

§  3 

Discrimination  by  the  Shorter  or  Shortest  Line ,  when  Such 
a  Line  has  Comparatively  Light  Traffic 

But  there  may  be  circumstances  under  which  it  is  the 
shorter  line  rather  than  the  longer  that  may  properly  be 
allowed  to  discriminate  in  favor  of  long-distance  as 
against  intermediate  traffic.  Turning  back  to  figure  13, 
let  us  suppose  that  the  longer  line,  ABCD ,  has  heavy 
local  traffic  and  is  therefore  able  to  charge  low  rates.  It 
may  charge  rates  between  A  and  D  which  are  higher, 
corresponding  to  the  greater  distance,  than  between  A 
and  C  or  B  and  D ,  and  which  are,  therefore,  in  no  sense 
discriminatory  against  intermediate  business,  but  which 
are,  though  remunerative,  very  low  per  mile.  The  more 
direct  line,  A  ED,  on  the  other  hand,  may  run  through 
a  territory  which  provides,  even  with  the  addition  of 
traffic  from  A  to  D  and  D  to  A ,  only  comparatively  light 
traffic,  and  this  shorter  railroad  may  therefore  be  com¬ 
pelled  to  charge  rates  per  ton  mile  much  higher,  on  the 
average,  than  are  charged  by  the  road  ABCD.  Yet 
if  the  railroad  A  ED  charges,  on  A  to  D  and  D  to  A 
shipments,  rates  per  mile  anything  like  as  high  as  it  is 
obliged  to  charge  on  A  to  E  and  D  to  E  traffic,  the  long¬ 
distance  traffic  will  go  by  the  roundabout  road.  To 
carry  a  share  of  this  longer  distance  traffic,  the  line  AED 
must  then  discriminate  in  its  favor. 

Let  us  look  more  fully  into  the  economic  problems 
involved.  If  the  long  line  is  not  discriminating  against 
intermediate  points  but  makes  the  low  longer  distance 


DEFENSIBLE  PLACE  DISCRIMINATION  13 1 


rates  simply  because  large  traffic  enables  it  to  make  all 
of  its  rates  low,  these  low  long-distance  rates  ought  not 
arbitrarily  to  be  raised.  The  railroad,  if  well  managed,  is 
entitled  to  a  fair  profit.  The  public,  if  large  business 
makes  such  rates  profitable,  is  entitled  to  low  rates,  and 
if  the  short  line,  because  traffic  on  its  rails  is  light,  cannot 
get  a  profit  except  by  charging  higher  rates  per  mile  on 
its  non-competitive  traffic,  it  is  fairly  entitled  to  do  this. 
The  A  to  D  traffic,  however,  will  not  add  to  the  fixed 
charges  or  general  expenses  of  the  railroad  A  ED  and, 
since  the  distance  is  shorter  over  its  line  than  over  that 
of  its  rival,  the  actual  expenses  of  moving  the  traffic, 
i.e.  the  expenses  for  the  production  of  train  mileage,  are 
probably 1  less  by  this  shorter  route.  Economic  waste 
may  therefore  be  avoided  by  encouraging  such  traffic  to 
follow  this  route  even  though  apparent  discrimination 
must  be  practiced  to  realize  that  end.  As  a  matter  of 
fact,  to  allow  the  line  A  ED,  under  these  assumed  cir¬ 
cumstances,  to  make  the  lower  rates  on  its  longer  dis¬ 
tance  traffic,  will  not  necessarily  increase,  and  may  de¬ 
crease,  the  disadvantage  to  which  intermediate  points 
on  this  line  are  subjected.  The  lower  A  to  D  rates 
very  likely  would  be  made,  any  way,  by  the  longer  and 
more  fully  utilized  road,  and  probably  ought  to  be  made 
by  that  road.  The  higher  rates  on  local  traffic  are 
essential  to  the  shorter  and  less  fully  utilized  road.  If 
this  shorter  road  can  get  some  of  the  A  to  D  and  D  to  A 
business,  it  will  perhaps  be  more  able,  rather  than  less 
able,  to  reduce  its  intermediate  rates. 

Likewise,  if  the  competition  between  two  or  more  rail- 


1  Not  necessarily,  because,  as  Professor  H.  J.  Davenport  has  suggested  to  me, 
the  more  direct  line  may  be  constructed  for  lighter  traffic,  with  resulting  higher 
operating  costs  per  ton  carried. 


132  TRANSPORTATION  COSTS  OF  COMMERCE 


roads  is  a  competition  of  directions  or  a  competition  of 
locations  (as  represented  in  figure  14),  there  may  some¬ 
times  be  similar  circumstances  justifying  place  discrim¬ 
ination  by  a  short  line. 


§  4 

Discrimination  among  Places ,  by  a  Railroad  Competing 

with  a  Water  Line 

Let  us  turn  now  to  another  condition  under  which 
discrimination  among  places  may  be  warranted.  Such 
discrimination  by  a  railroad  may  sometimes  be  war¬ 
ranted  when  the  railroad  has  to  meet,  at  certain  points, 
and  not  at  others,  the  competition  of  vessels  operating 
on  free  waterways,  e.g.  the  ocean.  Consider  the  case  of 
a  railroad  joining  the  three  points  A,  B ,  and  C  (see  figure 
15),  when  the  two  more  distant  points  from  each  other, 
A  and  C,  are  also  joined  by  a  water  transportation  line, 
and  when  the  intermediate  point  B  is  not.  Here  the 
railroad  ABC  will  make  relatively  low  rates  between  A 
and  C  to  meet  the  competition  of  the  water  line  .4C,  but 
will  not  be  compelled  to  make,  and  probably  will  not 
make,  correspondingly  low  rates  in  proportion  to  distance 
and  cost,  or,  in  some  cases,  even  absolutely,  between  A 
and  B  or  between  B  and  C.  Is  discrimination  among 
places,  by  a  railroad,  under  such  circumstances,  economi¬ 
cally  defensible  ? 

If  the  railroad  ABC  has  intermediate  traffic,  and  the 
water  line  has  only  the  traffic  from  A  to  C  and  C  to  A, 
then  we  have  a  problem  not  unlike  that  of  the  direct 
versus  the  roundabout  railroad,  when  the  latter  has  more 
intermediate  traffic.  In  our  figure,  the  water  route  is 
more  roundabout  than  the  rail  route,  but  this  may  be 


DEFENSIBLE  PLACE  DISCRIMINATION  133 


more  than  compensated  by  the  usually  lower  cost  of 
transportation  on  natural  waterways.  Yet  the  inter¬ 
mediate  traffic  on  the  rail  line  may  make  it  the  more 
economical  route.  For  the  extra  cost  of  taking  the 


through  traffic  over  the  same  railway,  since  this  extra 
cost  involves  no  greater  fixed  charges  or  general  expenses, 
may  be  less  than  the  cost,  counting  necessary  profit,  of 
carrying  the  goods  by  water.  It  will  then  be  economically 
desirable  that  the  railroad  plant  necessary  for  inter¬ 
mediate  traffic  should  be  fully  utilized,  before  vessels 
are  constructed  to  carry  the  A  and  C  traffic,  and  that 


134  TRANSPORTATION  COSTS  OF  COMMERCE 


these  vessels  should  be  constructed  only  in  sufficient 
number  to  take  the  surplus  A  and  C  traffic. 

Are  the  conclusions  otherwise  if  the  water  transporta¬ 
tion  company,  also,  has  a  considerable  amount  of  inter¬ 
mediate  traffic,  A  to  D,  D  to  C,  etc.  ?  There  is  a  possibil¬ 
ity  that,  in  this  case,  the  ability  to  get  part  of  the  through 
traffic  will  enable  the  water  line,  too,  to  carry  its  inter¬ 
mediate  traffic  more  cheaply.  Ability  to  get  both  most 
of  the  AC  traffic  and  this  intermediate  traffic  might 
make  it  possible  for  the  water  line  to  employ  and  to  fully 
utilize  larger  vessels,  and  to  realize  the  resulting  econ¬ 
omies.  If  so,  the  discrimination  resulting  from  the  com¬ 
petition  would  perhaps  be  practiced  by  the  water  line 
company  also,  to  the  relative  disadvantage  of  D;  or 
else  the  railroad  might  get  all  the  through  traffic,  smaller 
vessels  might  be  used  for  intermediate  traffic,  and  rates, 
because  costs,  might  be  higher  for  D.  B  and  D  would 
both  be  subjected  to  disadvantage,  and  industries  would 
be  prevented  from  locating  in  them,  because  there  was 
competition  at  A  and  C  and  none  at  B  and  D.  The 
objections  to  unlimited  discrimination  of  this  sort  on 
both  lines  are  the  same  as  were  previously  stated  1  for 
discrimination  practiced  by  each  of  two  railway  lines. 
The  ideal  of  economy  is  that  any  given  block  of  traffic 
between  A  and  C  should  be  carried  by  that  line  for  which 
the  special  additional  cost  of  carrying  it  is  the  less  (or 
least).  This  may  be  the  water  line  because  of  the  greater 
average  cheapness  of  water  transportation ;  or  it  may  be 
the  rail  line  despite  greater  average  costs,  because  of  a 
less  additional  cost  (train  mileage,  etc.)  for  hauling  the 
special  traffic  in  question. 

Very  possibly,  however,  competition  by  the  rail  line, 

1  See  §  i  of  this  Chapter  (V  of  Part  HI). 


DEFENSIBLE  PLACE  DISCRIMINATION  135 


ABC,  for  the  A  to  C  and  C  to  A  traffic,  will  not  appre¬ 
ciably  decrease  the  size  of  ships  used  on  the  line  A  DC 
but  only  their  number.  Neither  is  there  so  likely  to  be 
discrimination  against  D  as  against  B,  nor,  if  it  exists,  is  it 
likely  to  be  practiced  to  the  same  extent.  For  B  is  a 
monopoly  point  on  one  line,  while  traffic  to  and  from  D 
may  be  competed  for  by  any  independent  vessel.  Assum¬ 
ing,  then,  that  competition  on  the  waterway  is  so  evenly 
distributed  as  to  prevent  much  discrimination,  we  have 
to  inquire  into  the  justification  of  discrimination  by  the 
railroad.  At  the  most,  the  railroad  could  only  drive  the 
water  line  company  entirely  out  of  the  through  traffic 
A  to  C  and  C  to  A .  The  traffic  to  and  from  D  would  still 
be  carried  on  the  water  in  vessels  of  about  the  same  size 
and  at  about  the  same  rates.  The  only  question  is 
whether  it  is  well  for  the  community  and  for  points  such 
as  B  and  D,  that  the  railroad  should  take  the  longer 
distance  traffic  and  should  discriminate  to  do  so. 

To  illustrate,  let  us  suppose  that  the  article  competed 
for  is  cotton,  and  that  the  cost  of  carrying  it,  per  ton, 
between  A  and  C,  by  the  water  line,  is  $1.40.  Let  us 
suppose,  further,  that,  at  a  much  lower  rate  than  this,  it 
would  not  pay  to  operate  vessels  for  the  through  traffic 
between  A  and  C ;  that  the  surplus  vessels,  after  inter¬ 
mediate  traffic  was  provided  for,  would  seek  traffic 
elsewhere ;  and  that  at  such  low  rates,  no  new  ones  would 
be  built  for  the  A  and  C  traffic.  On  the  other  hand,  the 
cost  of  carrying  cotton  per  ton  from  A  to  C  on  the  rail¬ 
road  ABC  would,  we  may  assume,  if  this  freight  should 
pay  a  proportionate  share  towards  general  expenses ,  fixed 
charges ,  and  profits ,  amount  to  $1.50,  despite  the  com¬ 
parative  shortness  of  the  rail  route,  since,  in  general, 
water  transportation  on  free  and  open  waterways  is 


136  TRANSPORTATION  COSTS  OF  COMMERCE 


cheaper.  Nevertheless,  the  variable  expenses  for  carry¬ 
ing  the  A  to  C  traffic  by  rail,  i.e.  the  expenses  for  terminal 
services  and  for  the  production  of  train  mileage,  incident 
to  this  special  traffic,  may  be  not  more  than  $1.35  per 
ton.  Anything  over  that  may  contribute  towards 
general  expenses  and  towards  making  the  net  profits 
greater.  A  rate  of  $1.38  or  $1.39,  therefore,  would  be 
a  rate  at  which  the  railroad  would  much  rather  take  the 
business  than  lose  it. 

To  decide  whether  discrimination  by  the  railroad  is 
economically  desirable,  we  should  consider  the  interests 
of  all  places  and  transportation  companies  concerned, 
and,  therefore,  of  the  whole  community.  As  respects 
the  interests  of  the  places  A,  B ,  C,  and  D ,  it  is  to  be 
emphasized  that  the  traffic  between  A  and  C  will  get 
lower  rates  in  relation  to  distance  than  does  the  traffic 
between  A  and  B  and  between  B  and  C,  whether  the 
railroad  competes  or  not.  The  existence  of  the  waterway 
insures  this  discrimination,  if  it  may  properly  be  called 
such.  On  our  present  hypothesis  with  regard  to  size  of 
vessels,  the  competition  of  the  railroad  does  not  injure 
D.  There  are  no  general  expenses  for  maintaining  the 
water  route  which  now  have  to  be  borne  more  heavily  by 
D.  D  loses  only  relatively  and  in  proportion  as  A  and 
C  gain.  It  is  entirely  possible  that  the  discrimination 
against  B  would  be  greater  if  the  railroad  were  not 
allowed  to  compete.  For  then  it  would  not  have  been 
worth  while  even  to  build  such  a  road,  unless  the  inter¬ 
mediate  traffic  1  could  bear  rates  high  enough  to  make 
business  profitable  even  if  almost  no  competitive  business 
could  be  expected.  It  is  true  that  the  railroad,  if  al- 

1  Coupled  with  what  through  traffic  would  seek  the  railway  by  preference 
even  at  higher  rates. 


DEFENSIBLE  PLACE  DISCRIMINATION  137 


lowed  to  add  to  its  profits  by  taking  part  of  the  A  to  C 
and  C  to  A  business,  might  not  merely  on  that  account 
voluntarily  make  lower  intermediate  rates.  But  so  far 
as  these  rates  are  subject  to  government  or  commission 
control,  their  reduction  could  be  secured  with  more  ap¬ 
parent  equity  and  therefore  ease,  if  it  appeared  that 
the  railroad  could  afford  such  reduction.  From  the  point 
of  view  of  B,  therefore,  or  other  intermediate  points  on 
the  railroad  ABC,  it  would  hardly  appear  that  reason¬ 
able  competition  by  this  railroad  for  the  through  traffic, 
should  be  opposed.  The  intermediate  rates  would  not 
suffer  in  consequence,  and  might  even,  with  effective 
government  regulation,  be  made  lower.  A  and  C  have 
something  to  gain  from  the  competition  and  nothing 
to  lose.  As  to  the  rail  versus  the  water  line,  if  the  rail¬ 
road  can  afford  to  carry  the  freight  without  loss  and  even 
with  some  gain  to  itself,  at  a  rate  so  low  that  no  one 
would  build  vessels  to  meet  that  rate,  then,  presumably, 
investment  in  such  vessels  would  be  uneconomical. 
Those  who,  in  the  absence  of  the  railroad,  would  so  invest, 
turn  their  control  over  capital  to  other  lines,  or  to  naviga¬ 
tion  between  other  cities,  and  it  cannot  be  said  that  they 
lose  more  than  the  railroad  company  gains.  If  it  is 
almost  worth  while  to  build  the  railroad  for  the  inland 
transportation  alone,  and  if  the  competitive  traffic, 
even  at  rates  below  what  a  water  line  could  profitably 
meet,  makes  it  entirely  worth  while,1  then  it  is  better  to 
have  the  railroad  than  to  have  the  additional  ships 
necessary  to  carry  the  A  to  C  traffic.2  The  Federal  law 

1  Cf.  Taussig,  Principles  of  Economics,  New  York  (Macmillan),  1911,  Vol.  II, 
P-  374- 

2  On  the  other  hand,  it  may  often  be  desirable  for  railroads  to  charge  rates  on 
traffic  moving  short  distances,  which  pay  but  little  towards  general  expenses 
and  profits,  rather  than  have  the  goods  carried  by  wagons  or  auto-trucks.  Where 


i38  TRANSPORTATION  COSTS  OF  COMMERCE 


and  the  Interstate  Commerce  Commission  in  its  interpre¬ 
tation  of  that  law,  are  therefore  to  be  commended  for 
recognizing  water  competition  when  of  substantial 
importance,  as  possible  justification  for  discrimination 
by  a  railroad  between  places.1 

A  good  illustration  of  the  effect  of  water  competition  is 
found  in  the  facts  brought  out  in  the  St.  Louis  Business 
Men’s  League  case  decided  by  the  Interstate  Com¬ 
merce  Commission  in  1902. 2  It  appeared,  first,  that  the 
transcontinental  railroads  were  charging  much  lower 
rates  to  the  Pacific  Coast  than  to  far  western  points  not 
on  the  coast.  Even  points  a  considerable  distance  inland 
had  to  pay  higher  rates  on  goods  from  the  East  than  did 
coast  points.  The  rates  to  these  inland  points  were 
based  on  the  coast  rates.  That  is,  from  points  east  of  the 
Mississippi  or  Missouri  rivers,  rates  were  made  to  various 
far  western  points,  which  were  the  sum  of  the  competitive 
rates  to  the  coast  and  the  local  rates  back  to  those  far 
western  points.  This  situation,  the  rail  carriers  claimed, 
was  due  to  water  competition  at  the  longer  distance 
points.  F rom  ports  on  the  Atlantic  Coast,  goods  can 
go  to  the  Pacific  Coast  by  water  around  Cape  Horn ;  by 
water  to  Panama,  and,  after  crossing  the  Isthmus  (or 


low  rates  are  made  for  this  reason,  such  low  rates  may  be  defensible  from  the 
viewpoint  of  national  economy,  even  though  traffic  moving  longer  distances  has 
o  pay  more  towards  profits.  For,  unless  the  transportation  plant  is  already 
fully  utilized  by  traffic  which  is  more  profitable,  it  may  be  better  that  this  short- 
distance  traffic  should  be  taken  by  the  railroad  in  question,  already  and  properly 
there  for  the  sake  of  other  business,  than  that  additional  capital  should  be  in¬ 
vested  in  the  other  facilities  (trucks,  etc.)  for  conveyance. 

1  See  discussion  by  the  Interstate  Commerce  Commission  regarding  section  4 

of  the  law  m  its  present  form,  in  the  Twenty-fifth  Annual  Report  of  the  Com¬ 
mission,  p.  26. 

■  Interstate  Commerce  Reports,  Vol.  IX,  pp.  3i8-372.  See  also  Twenty-6fth 
Annua!  Report  of  the  Interstate  Commerce  Commission,  pp.  j7-4i,  for  discussion 
by  the  Commission,  of  a  more  recent  case  involving  transcontinental  rates. 


DEFENSIBLE  PLACE  DISCRIMINATION  139 


going  through  the  canal,  as  will  soon  again  be  possible), 
by  water  up  the  coast;  or  the  goods  may  go  by  rail 
across  the  United  States  or  Canada.  In  consequence 
of  the  water  competition,  the  rates  to  Pacific  Coast  ports 
must  be  low ;  but  they  need  not  be  equally  low  to  in¬ 
terior  western  cities.  It  appeared,  second,  that  rates 
from  Pittsburg,  Chicago,  St.  Louis,  and  other  cities  east 
of  the  Mississippi  and  Missouri  rivers,  but  not  on  the 
Atlantic  Coast,  were  just  as  low  to  the  Pacific  Coast 
as  rates  from  Atlantic  ports,  but  were  no  lower.  In 
the  absence  of  water  competition,  rates  from  these  in¬ 
terior  cities  to  the  western  coast,  would,  in  all  proba¬ 
bility,  be  lower  than  rates  from  Atlantic  ports  to  the 
coast.  While  other  conditions  have  been  such  that 
water  competition  has  not  made  rates  from  the  Atlantic 
ports  actually  lower  than  from  these  interior  cities, 
it  has  made  them  lower  in  comparison  with  distances 
carried. 

Here,  then,  we  have  discrimination  by  railroads  in 
favor  of  that  part  of  their  traffic  which  is  subject  to 
water  competition.  Yet  if  the  railroads  must  so  dis¬ 
criminate  to  get  the  through  business,  if  the  through 
business,  even  at  these  low  rates,  will  pay  the  extra  cost 
of  its  own  moving  and  something  towards  general  ex¬ 
penses  and  profits,  and  if  correspondingly  low  rates  on 
all  the  intermediate  traffic  carried  cannot  be  afforded, 
the  competition  by  the  railroads,  if  not  carried  to  undue 
lengths,  would  appear  to  be  legitimate.1 


1  Discrimination  to  the  same  degree  may  not  be  defensible  when  the  railroad 
in  question  is  taxed  to  its  uttermost  to  carry  the  traffic  which  is  non-competitive 
with  any  water  transportation  company.  It  is  certainly  not  desirable,  either 
for  the  good  of  the  railroad  or  that  of  the  public,  that  intermediate  traffic,  which 
has  no  alternative  route  and  which  can  pay  reasonably  high  rates,  should  be 
refused  in  order  that  competitive  traffic,  which  has  an  alternative  route  and  will, 


i4o  TRANSPORTATION  COSTS  OF  COMMERCE 

The  same  principles  apply  when  the  competition  is, 
in  part  or  in  whole,  a  competition  of  directions  or  a  com¬ 
petition  of  locations.  In  transcontinental  business,  the 
lines  leading  from  Chicago  and  St.  Louis,  as  well  as  those 
leading  from  Boston,  New  York,  etc.,  make  lower  rates 
to  the  coast  than  to  interior  western  points.  If  they 
did  not,,  goods  which  are  produced  in  Chicago  and 
St.  Louis  for  western  consumption,  and  which  go 
west  by  rail,  would  be  likely,  in  part,  to  be  produced 
m  Boston,  New  York,  etc.,  and  to  go  west  by  water. 
Low  rates  on  the  railroads  for  such  competitive 
traffic,  even  though  the  competition  is  not  of  routes, 
may  more  fully  utilize  railroad  plants,  may,  therefore' 
increase  railroad  profits,  and  may  add  to  railroad 
facilities  for  intermediate  points.  A  recent  decision 

therefore,  pay  only  low  rates,  should  be  taken.  If  the  railroad  is  already  fully 
utilized,  without  the  competitive  traffic,  it  cannot  properly  seek  part  of  this 
competitive  traffic  unless  by  extending  its  plant,  —  for  example,  by  constructing 
an  additional  track.  In  such  a  case,  the  competitive  traffic  should  not  be  sought 
unless  it  will  pay,  besides  the  train  mileage  and  terminal  costs  which  it  occasions, 
a  reasonable  return  on  the  extra  capital  (e.g.  trackage)  required  (cf.  M.  O. 

orenz,  Constant  and  Variable  Railroad  Expenditures  and  the  Distance  Tariff 
Quarterly  Journal  of  Economics,  Vol.  XXI,  1907,  pp.  283-298).  We  need  not 
conclude,  however,  that  no  discrimination  whatever  in  favor  of  the  competitive 
traffic  can,  under  these  conditions,  be  justified.  For  in  order  to  carry  increased 
traffic,  it  is  possible  that  the  railroad  plant  will  not  have  to  be  increased  in  the 
same  ratio.  A  two-track  railroad,  for  example,  will  carry  more  than  twice  as 
much  traffic  as  a  one-track  road.  Consequently,  even  though  the  competitive 
traffic  requires  a  greater  railroad  plant  than  would  be  necessary  if  this  traffic  were 
left  to  the  water  line,  such  traffic  may  not  involve,  and  if  the  size  of  plant  of 
maximum  efficiency  has  not  been  reached,  will  not  involve,  additional  cost  in 
proportion  to  its  volume;  and  it  may  perhaps  be  carried,  with  economic  justifica¬ 
tion,  at  rates  slightly  lower  in  relation  to  distance  than  the  rates  between  points 
not  served  by  waterways.  As  a  matter  of  fact,  the  trackage  which  is  in  any  case 
required  for  intermediate  traffic,  often  suffices,  without  increase,  for  the  competi¬ 
tive  traffic  also.  Though  engines  and  cars  may  have  to  be  increased,  yet,  in  the 
main,  the  additional  business  sought  merely  utilizes  existing  plant  more  com¬ 
pletely.  Also,  if  trackage  has  been  mistakenly  constructed  in  excess  of  the  needs 
of  traffic  which  can  pay  reasonable  rates,  it  may  be  better  to  accept  competitive 
traffic  which  pays  but  little  towards  profit,  than  to  refuse  it. 


DEFENSIBLE  PLACE  DISCRIMINATION  141 


of  the  Interstate  Commerce  Commission,1  still  more 
recently  upheld  by  the  Supreme  Court,2  limits  the  extent 
to  which  this  discrimination  may  be  carried,  and  limits 
it  more  closely  for  lines  leading  from  the  Middle  West 
than  for  those  leading  from  the  Atlantic  Coast.  Rates 
from  Atlantic  Coast  territory  to  western  points  not  on 
the  Pacific  Coast  must  not  exceed  rates  to  the  Pacific 
Coast  by  more  than  25  per  cent.  From  Buffalo  and 
Pittsburg  territory  the  discrimination  must  not  exceed 
15  per  cent.  From  Chicago  territory  it  must  not  be  in 
excess  of  7  per  cent.3  But  the  influence  of  the  ocean 
route  is  clearly  recognized  by  this  ruling,  and,  as  the 
above  percentages  show,  some  discrimination  is  still 
allowed.4  From  Missouri  River  points,  however,  such 


1  Interstate  Commerce  Commission  Reports,  Vol.  XXI,  pp.  329-384. 

2  See  Intermountain  Rate  cases,  234  U.  S.,  476. 

3  The  argument  has  been  advanced  that  lines  leading  from  the  middle  western 
cities  have  less  of  adequate  economic  justification  for  discriminating  in  favor  of 
traffic  to  the  coast,  because  the  competition  they  have  to  meet  is  only  or  chiefly 
that  of  markets,  i.e.  directions  and  locations  (see  the  Twenty-fifth  Annual  Report 
of  the  Interstate  Commerce  Commission,  pp.  27-41,  and  Ripley,  Railroads,  Rates 
and  Regulation,  New  York  —  Longmans,  Green,  and  Co. — ,  1912,  pp.  610-626). 
The  considerations  discussed  above  in  the  text  would  seem  to  justify  a  certain 
amount  of  such  discrimination,  though  not,  of  course,  an  unlimited  amount  of  it. 
It  must  be  emphasized  that  the  competition  is  none  the  less  a  competition  with 
water  lines,  because  it  is,  for  instance,  a  competition  of  locations.  It  may  be 
truer  economy  that  goods  should  go  by  rail  and,  if  they  do  go  by  rail,  it  is  prob¬ 
ably  cheaper,  so  far  as  transportation  is  concerned,  that  they  should  be  sent  from 
the  Middle  West  than  that  they  should  go  from  the  extreme  East.  Neverthe¬ 
less,  it  is  probably  justifiable  to  require,  as  the  Interstate  Commerce  Commission 
has  done,  less  discrimination  on  the  traffic  from  the  Middle  West  to  Pacific 
Coast  points  as  against  intermediate  points,  than  on  the  traffic  from  the  East. 
For  while  it  may  be  plausibly  contended  that  rates  from  the  Middle  West  to  the 
Pacific  Coast  should  not  be  made  lower  than  those  from  the  Atlantic  Coast, 
in  view  of  the  lowness  of  the  latter  rates,  it  does  not  follow  that  to  intermediate 
far  western  points,  to  which  the  rates  from  the  East  are  not  thus  exceptionally 
low,  the  rates  from  the  Middle  West  should  not  be  lower.  Since  the  distance  is 
less,  they  probably  should  be  lower. 

*  In  a  decision  of  Feb.  12,  1915,  the  Commission  modified  this  order 
somewhat,  as  to  certain  heavy  commodities  likely  to  move  by  water.  This 


142  TRANSPORTATION  COSTS  OF  COMMERCE 


as  Kansas  City  and  Omaha,  and  from  points  farther 
west,  no  discrimination  whatever  is  permitted. 

Before  this  topic  is  dropped,  a  warning  should  be 
given  against  interpreting  too  loosely  the  conclusions 
reached.  It  is  not  true  that  a  railway  is  always  justified 
in  competing  with  a  water  transportation  line,  however 
low  rates  the  latter  can  make.  If  a  railroad,  in  order  to 
compete  with  a  water  line,  accepts  rates  below  the  actual 
additional  cost  incurred  for  loading,  hauling,  and  unload- 
ing  the  traffic  sought,  it  is  engaged  in  illegitimate  compe¬ 
tition  at  the  expense  of  its  owners,  or  of  the  non-com¬ 
petitive  points  it  serves,  or  both.  As  the  Interstate 
Commerce  Commission  well  expressed  the  matter,  in  one 
of  its  early  cases,1  “Rail  rates  that  sacrifice  all  benefits 
to  the  carrier  from  the  business  in  order  to  divert  it  from 
competitors  by  water,  are  destructive  and  illegitimate 
competition.  .  .  .  When,  therefore,  a  rail  carrier  reduces 
its  rates,  to  compete  with  a  water  carrier,  below  the 
average  necessary  for  its  own  proper  uses,  it  takes  upon 
itself  the  onus  of  showing  that  the  reduction  does  not 
result  in  actual  loss,  so  as  to  impose  a  burden  on  other 
traffic  and  does  not  unjustly  discriminate  against  local¬ 
ities  that  are  charged  higher  rates  on  like  traffic.”  Such 
illegitimate  competition  is  likely  to  ruin  a  water  line 
because  the  water  line  is  less  apt  to  have  non-competitive 
business  from  which  it  can  recoup  itself.  A  railroad,  on 
the  other  hand,  can  reduce  its  rates,  engage  in  the 
competitive  part  of  its  business  at  an  actual  loss,  and,  if 
allowed  by  government  to  do  so  and  not  already  charging 

was  done  to  enable  the  railroads  more  easily  to  meet  competition  via  the 
Panama  Canal.  (See  Interstate  Commerce  Commission  Reports,  Vol.  XXXII, 
pp.  611-658.) 

1  Interstate  Commerce  Commission  Reports,  Vol.  IV,  p.  26  (pp.  1-30  for  entire 
case). 


DEFENSIBLE  PLACE  DISCRIMINATION  143 


all  the  traffic  will  bear,  shift  the  burden  to  other  and 
profitable  parts  of  its  line.  But  successful  competition 
of  this  sort  is  not  a  proof  of  superior  efficiency  or  cheap¬ 
ness.  It  does  not  mean  that  there  is  no  economic  waste 
in  using  the  railroad  by  preference  to  the  water  line.  It 
is  success  won  by  carrying,  temporarily,  at  rates  for 
which  the  competing  railroad  or  railroads  will  not  carry 
permanently.1  It  is  like  the  practice  of  some  capitalistic 
monopolies  or  trusts,  of  lowering  prices  in  a  given  locality, 
far  below  cost,  as  a  temporary  measure  to  drive  out  a 
competitor,  while  maintaining  elsewhere  high  prices. 
The  ruin  of  the  small  competitor  by  such  competition  is 
no  proof  that  he  cannot  produce  even  more  cheaply 
than  the  trust.2  The  Interstate  Commerce  Act  as 
amended  in  1910  penalizes  such  illegitimate  competi¬ 
tion  of  railroads  against  water  transportation  com¬ 
panies,  by  providing  that  railroad  rates  reduced  on 
traffic  competitive  with  a  water  line  cannot  be  raised 
again  except  by  permission  of  the  Interstate  Commerce 
Commission,  and  that,  to  secure  this  permission,  changed 
conditions  must  be  shown  other  than  the  elimination  of 
water  competition.3 


1  Cf.  Report  of  Inland  Waterways  Commission,  1909,  pp.  385,  386 ;  also 
Preliminary  Report  of  National  Waterways  Commission,  1911,  p.  10  (p.  72  of 
Final  Report,  1912). 

2  Another  illegitimate  method  of  competition  has  been  the  attempt  to  dis¬ 
criminate  in  rail  charges,  against  shippers  using  waterways  for  a  part  of  their 
business.  It  is  asserted  (Report  of  the  Inland  Waterways  Commission,  1909, 
p.  386)  that  this  kind  of  discrimination  existed  in  France  until  the  government 
put  an  end  to  it.  Most  shippers  are  dependent  upon  railways  to  reach  at  least 
a  part  of  their  customers.  They  can  often  get  along  without  competing  water¬ 
ways,  but  seldom  without  railways.  If  the  railways  can,  with  impunity,  deny 
them  reasonable  rates  or  fair  service,  recalcitrant  shippers  wishing  to  use  water¬ 
ways  can  frequently  be  brought  to  terms,  and  compelled  to  agree  to  ship  all 
their  output  by  rail. 

3  Section  4  of  the  amended  act. 


144  TRANSPORTATION  COSTS  OF  COMMERCE 


Discrimination  among  Places ,  by  a  Railroad  Competing 

with  Local  Self-sufficiency 

Discrimination  among  places  can  be  defended  as 
economically  good,  in  certain  cases  where  a  railroad  is 
pitted  against  local  self-sufficiency.  Suppose  a  railroad 
from  distant  coal  fields  about  A  leads  into  a  region,  C, 
where  coal  can  be  produced,  but  at  a  somewhat  greater 
expense  than  at  A.  (See  figure  16.)  Suppose  the  cost 

B 

A* - - %Q 

Figure  16 

at  C  to  be  $6  a  ton  and  at  A,  $4.20  a  ton ;  and  suppose 
that  coal  cannot  be  produced  at  A  for  sale  in  C,  unless  the 
A  coal  producers  receive  at  least  this  $4.20.  A  lower 
price  would,  we  assume,  cause  A  producers  to  desert  the 
poorer  mines  to  such  an  extent  that  there  would  be  no 
exportable  surplus.  The  populations  at  A  and  at  C 
would  then  both  be  more  self-sufficient  than  if  A  sent 
coal  to  C,  and  received  other  goods  in  exchange.  Under 
these  assumed  circumstances  (and,  where  distances  are 
great,  similar  circumstances  may  exist  in  fact),  the  rate 
charged  for  carrying  the  coal  from  A  to  C  cannot  exceed 
$1.80  a  ton.  The  road  ABC  must  get,  it  may  be,  on  the 
most  of  its  coal  traffic,  a  rate  corresponding  to  $2  a  ton 
for  such  a  distance  as  A  to  B.  Otherwise,  the  company 
cannot  pay  expenses  and  a  fair  profit.  Nevertheless, 
$1.80  or  even  $1.75  a  ton,  for  carrying  coal  from  A  to  C, 
will  pay  extra  costs  incident  to  moving,  and  leave  a  small 
amount  towards  other  ends. 

Under  these  circumstances,  the  railroad  is  better  off  to 


DEFENSIBLE  PLACE  DISCRIMINATION  145 


get  the  traffic.  The  consumers  at  C  have  something  to 
gain  and  nothing  to  lose  from  having  the  coal  brought 
from  A.  Any  resulting  price  reduction  benefits  them 
as  much  as  or  more  than  it  injures  producers  at  C.  The 
coal  producers  at  A ,  where,  we  assume,  natural  advan¬ 
tages  make  the  labor  cost  of  production  lower,  gain  at 
least  as  much  business  from  the  opening  to  them  of  the 
market  at  C,  as  the  producers  at  C  lose.  Intermediate 
points,  such  as  B,  will  not  have  to  pay  any  higher  rates 
than  they  would  have  to  pay  anyway,  and  it  may  be 
possible,  because  of  the  through  traffic,  to  make  the 
rates  charged  to  the  intermediate  places  less  than  would 
otherwise  be  necessary.  Perhaps,  were  it  not  for  the 
through  traffic,  the  railroad  would  never  be  constructed, 
and  the  intermediate  points  would  fail  to  get  any  service 
at  all.  The  railroad  plant  is  more  fully  utilized  by  taking 
the  long-distance  traffic.  It  may  be  desirable,  therefore, 
that  C  should  be  supplied  with  coal  from  A  and  that  the 
railroad  ABC  should  discriminate  to  bring  about  that 
end. 

§  6 


Discrimination  in  Favor  of  Export  Traffic 

We  have  seen  that  competition  between  a  number  of 
transportation  lines,  causing,  on  all  of  them,  discrimina¬ 
tion  against  non-competitive  points,  involves  economic 
waste.  But  if  the  system  of  discrimination  exists,  the 
interests  of  any  one  line  (or  group  of  lines),  and  of  the 
territory  it  serves,  may  be  more  promoted  by  its  engaging 
in  the  competitive  traffic  at  the  rates  competition  deter¬ 
mines,  than  by  its  relinquishing  such  traffic  to  its  rivals. 
For  some  profit  is  better  than  none,  and  may  make 
possible  service  otherwise  unattainable  by  intermediate 
part  m  —  L 


146  TRANSPORTATION  COSTS  OF  COMMERCE 


points,  or  lower  rates  than  these  points  could  otherwise 
enjoy. 

The  same  kind  of  argument  tends  to  show  that  dis¬ 
crimination  by  the  transportation  lines  of  a  country,  in 
favor  of  goods  exported  as  against  goods  sold  in  the  home 
country,  may  be  economically  profitable  for  that  country 
even  if  unprofitable  from  the  viewpoint  of  world  eco¬ 
nomics.  We  may  illustrate  the  various  possibilities 
of  national  gain  or  loss  by  reference  to  a  case  decided 
by  the  Interstate  Commerce  Commission  in  1899.1  It 
appeared,  in  this  case,  that  the  export  rates  upon  grain, 
not  only  through  the  Gulf  ports  (by  which  route  the 
argument  regarding  roundabout  lines  might  apply),  but 
even  through  the  Atlantic  ports,  including  New  York, 
were,  at  times,  lower  than  the  rates  upon  grain  carried 
to  the  same  ports  for  domestic  consumption.  Thus,  dur¬ 
ing  October  of  1896,  the  rate  on  corn  from  Chicago  to 
New  York  was  20  cents  for  domestic  consumption  as 
contrasted  with  15  cents  if  for  export.  Discrimination 
of  the  same  sort  was  shown  to  have  sometimes  been 
practiced  in  favor  of  exported  wheat. 

Such  discrimination  we  may  show  to  be  a  gain  to  the 
United  States  as  a  whole,  on  the  following  hypotheses : 
first,  that  these  low  rates  cover  at  least  the  additional 
cost  incident  to  carrying  the  freight  in  question,  i.e. 
terminal  and  production-of-train-mileage  expenses  im¬ 
posed  by  this  particular  business;  second,  that  these 
low  rates  are  all  which  the  traffic  will  bear  without  being, 

1  Interstate  Commerce  Reports,  Vol.  VIII,  pp.  214-276.  Attention  should 
be  called  to  the  fact  that  under  section  4  of  the  original  Interstate  Commerce 
Act,  as  it  had  been  interpreted  by  the  Supreme  Court  (162  U.  S.,  197  and  168 
U.  S.,  144)?  the  Commission  did  not  have  the  power  to  correct  the  discrimination 
in  favor  of  exports  complained  of.  The  amendment  of  1910  has  given  it  more 
effective  control  over  situations  of  this  sort. 


DEFENSIBLE  PLACE  DISCRIMINATION  147 


not  merely  diverted  from  one  American  transportation 
company  to  another,  but,  so  far  as  American  railroads 
are  concerned,  in  a  considerable  degree  lost,  i.e.  that  the 
railroads  must  make  the  discriminating  rates,  to  get  the 
largest  returns  from  the  business.  Under  these  circum¬ 
stances,  low  rates  made  on  export  wheat,  for  instance, 
by  American  railroads,  would  mean  a  net  gain. 

At  first  sight  this  discrimination  may  seem  like  a 
bounty  on  exportation.  But  there  is  a  very  distinct 
difference  which  destroys  the  value  of  any  such  compari¬ 
son.  A  bounty  is  a  clear  loss  to  a  country’s  taxpayers. 
At  their  expense,  it  turns  industry  into  a  line  which, 
otherwise,  it  might  not  follow  and  which,  therefore,  is 
likely  to  be  a  nationally  unprofitable  line  of  industry. 
But  the  discrimination  in  freight  rates,  favorable  to 
exported  goods,  is  not,  on  our  hypothesis,  a  direct  loss 
to  any  class  of  persons  in  the  community.  Even  if  any 
class  of  persons  suffers  indirect  loss  in  consequence, 
others  in  the  country  gain  as  much  or  more.  The  rail¬ 
roads,  by  making  the  discrimination,  secure  traffic  which 
they  otherwise  could  not  get,  and  are,  therefore,  able, 
since  they  are  operated  under  a  law  of  decreasing  pro¬ 
portionate  expense,  to  pay  greater  profits.1  The  railway 
plant  may  be,  thereby,  more  fully  utilized.  Even  if, 
without  low  export  rates,  it  would  not  pay  for  wheat 
production  to  be  carried  on  to  the  same  extent,  for  export, 
the  fact  that,  by  carrying  it  on,  the  railway  plant  already 
constructed  for  domestic  business  can  be  more  fully 
utilized,  makes  the  business  of  wheat  production  for 
export  an  economical  and  desirable  business.  If  the 
railroads  are  not  allowed  thus  to  discriminate,  within 
limits,  and  if,  in  consequence,  the  production  of  wheat 

1  Or,  if  compelled,  to  reduce  average  rates. 


148  TRANSPORTATION  COSTS  OF  COMMERCE 


for  export  is  not  carried  on,  or  is  carried  on  to  a  much  less 
extent,  then  the  railway  plants  will  be  likely  to  be  less 
utilized,  to  the  disadvantage  of  the  railways  of  the 
country,  and  of  the  general  public.  For  it  is  reasonably 
probable  that  any  other  industry  or  industries,  to  which 
those  who  would  have  produced  wheat  for  export  turn 
their  hands,  will  involve  less  transportation  than  the 
wheat,  and  perhaps  at  rates  no  more  profitable.  Such 
another  industry  will  be,  in  part,  production  for  a  local, 
or  at  any  rate  a  home,  market.  The  essential  fact  to 
remember,  is,  that  since  railroads  are  operated  under 
conditions  of  joint  cost,  the  carriage  of  export  grain,  even 
at  low  rates,  may  help  to  make  the  railroads  pay.  It 
may  help,  therefore,  to  make  possible  the  building  of 
railroads  where  they  might  not  otherwise  be  built,  and 
service  to  the  community,  which  might  not  otherwise  be 
available.  It  may  make  possible  a  lower  average  scale 
of  rates  1  and  so  tend  to  facilitate  greater  development 

1  The  argument  by  which  the  sale  of  goods  abroad  by  tariff-protected  American 
manufacturing  companies  at  prices  lower  than  those  charged  at  home  for  the 
same  goods  is  sometimes  defended,  bears  a  superficial  resemblance  to  the  argu¬ 
ment  in  favor  of  discriminating  rates  on  export  traffic.  It  is  said  that  the  prices 
at  home  of  such  manufactured  goods  may  be  no  higher,  since  the  additional  sup¬ 
ply  produced  for  export  may  be  produced,  by  more  fully  utilizing  manufacturing 
plants,  at  less  proportionate  cost.  In  other  words,  the  lower  price  abroad  of 
American  goods,  if  made  necessary  by  the  competition  of  cheap  foreign  produced 
goods,  is  not  at  the  expense  of  the  American  consuming  public. 

But  there  is  at  least  one  very  important  difference  between  the  two  cases. 
Transportation  within  the  United  States,  and  to  the  ports  and  boundaries  of  the 
country,  must  be  provided  by  labor  carried  on  within  the  United  States  and 
by  transportation  plants  located  here.  Absolute  freedom  of  trade  would  not 
enable  us  to  utilize  the  labor  of  foreign  railway  employees  in  carrying  American 
goods  to  ports  of  export.  Our  railways  may,  indeed,  be  the  most  efficient  in  the 
world ;  but  whether  they  are  or  not,  we  cannot  substitute  foreign  railways  for 
them.  Manufactured  goods,  on  the  other  hand,  can  be  supplied  to  us  directly 
by  our  own  labor  and  capital,  or,  if  trade  is  not  too  greatly  interfered  with,  by 
labor  and  capital  engaged  in  production  in  a  different  part  of  the  world.  An 
alternative  therefore  exists  for  us  in  the  case  of  such  goods,  that  does  not  exist 
m  the  case  of  transportation  service.  Protection  shuts  off  that  alternative. 


DEFENSIBLE  PLACE  DISCRIMINATION  149 


of  other  industries  also,  and  greater  geographical  division 
of  labor  within  the  exporting  country.  If  the  greater 
business  makes  lower  rates  a  possibility,  the  stimulus 
of  competition,  or  the  pressure  of  the  public  through  its 
commissions,  may  make  these  potential  lower  rates  actual. 

Let  us  consider  the  effects  of  this  sort  of  discrimination 
on  the  different  classes  of  Americans  concerned.  We 
may  at  once  cancel  out  the  effects  upon  American  pro¬ 
ducers  and  upon  domestic  consumers  of  changes  caused 
on  the  price  of  grain  consumed  at  home.  If  the  railroads, 
by  low  rates  on  export  grain,  make  it  possible  for  Ameri¬ 
can  farmers  to  get  more  for  their  wheat  sold  abroad 
(because  a  less  charge  for  transportation  is  subtracted 
from  the  foreign  prices),  and  if,  consequently,  these 

If  American  factories,  in  any  line  of  manufacture,  produce  goods  at  such  great 
expense  that  they  must  get  higher  prices  from  domestic  consumers,  in  order  to 
remain  in  business,  than  they  are  compelled  to  accept  on  that  portion  of  their 
goods  which  they  sell  in  foreign  markets,  then  it  is  probable  that,  except  for  the 
tariff,  foreign  producers  would  undersell  them  in  the  United  States,  that  their 
high  prices  at  home  are,  therefore,  at  the  expense  of  American  consumers,  and 
that  the  protected  industry  (or  industries)  is  of  the  parasitic  kind  and  should 
never  have  been  encouraged. 

Even  if  the  tariff  is,  in  any  case,  to  be  maintained  in  favor  of  a  given  line  of 
manufacturing,  it  is  not  impossible  that  the  sale  of  surplus  goods  abroad,  for 
their  bare  additional  cost  of  production  to  each  factory,  will  increase  the  price  or 
prices  which  home  consumers  must  pay.  Suppose  that  there  are  io  domestic 
factories  of  about  the  same  capacity,  and  that  each,  in  order  fully  to  utilize  its 
capacity,  sells  ^  of  its  total  output  abroad  at  a  low  price,  while  covering  fixed 
and  general  expenses  mainly  from  the  money  received  on  goods  sold  at  home. 
Is  it  not  evident  that  if  the  foreign  business  were  not  sought  and  if  the  home 
demand  were  taken  care  of  by  9  factories,  the  10th  not  being  built,  then  total 
manufacturing  plant  might  be  just  as  fully  utilized,  and  that  the  benefit  in  re¬ 
duced  price  might  then  go  to  domestic  consumers?  Unless  the  size  of  plant  of 
maximum  efficiency  was  a  monopoly  size,  discrimination  in  prices  in  favor  of 
foreign  consumers  could  but  add  to  the  injury  to  home  consumers  caused  by  the 
tariff.  But  in  the  case  of  railways,  the  alternative  of  a  smaller  number  of  plants, 
though  it  may  “exist,  probably  does  not  exist  to  the  same  degree.  Since  the  trans¬ 
portation  service  required  in  each  section  of  the  country  must  be  provided  by 
transportation  lines  in  that  section,  most  of  the  existing  trackage,  perhaps  all  of 
it,  would  equally  be  present  whether  export  traffic  requiring  discriminatingly  low 
rates  were  sought  or  not. 


150  TRANSPORTATION  COSTS  OF  COMMERCE 


farmers  get  higher  prices  for  the  wheat  which  they  sell 
at  home,  their  gain  from  wheat  sold  at  home  is  pre¬ 
sumably  just  equal  to  the  consumers’  loss.  No  net 
effect  is  produced  on  the  national  wealth.1 

Our  problem  narrows  itself  down,  therefore,  to  a  con¬ 
sideration  of  the  effects  of  this  kind  of  rate  making,  on 
American  railroads,  and  on  American  producers  in  so  far 
as  they  are  producers  for  export.  Obviously,  a  reduction 
of  railroad  rates  on  exported  grain  could  not  injure 
American  producers.  Whatever  might  be  true  of  market 
conditions  abroad,  and  however  market  price  abroad  of 
American  wheat  might  be  determined,  reduction  of  these 
transportation  rates  would  not  reduce  the  foreign  price 
by  more  than  an  equivalent  amount.  It  could  not  induce 
or  compel  the  American  farmer  to  accept  a  net  price, 
after  subtracting  low  transportation  charges,  even  lower 
than  if  these  charges  were  high.  The  whole  difference 
between  high  and  low  transportation  rates  might  or 
might  not  be  subtracted  from  the  price  to  the  foreign 
consumer,  but,  certainly,  more  than  that  difference  the 
foreign  consumer  could  not  hope  to  gain.  To  assume  a 
greater  gain  for  the  foreign  consumer  would  be  to  as¬ 
sume  that  the  American  farmer  would  send  more  wheat 
abroad  at  a  lower  net  price  than  at  a  higher  net  price. 
The  American  farmer,  then,  cannot  lose  by  a  reduction  in 
rates  on  wheat  for  export,  and  he  must  gain,  on  wheat 
consumed  in  the  United  States,  whatever  the  domestic 
consumer  loses.  If,  therefore,  the  railroads  in  the 
United  States  gain  enough  by  the  consequent  greater 
traffic,  to  make  the  low  export  rates  more  profitable  to 
them  than  higher  ones  would  be,  the  net  effect  is  an 

1  If  inflow  of  money,  because  of  greater  exports,  raises  other  prices,  the  effects 
are  again  two-sided,  and  the  above  conclusion  remains  true. 


DEFENSIBLE  PLACE  DISCRIMINATION  15 1 


increase  of  national  prosperity.  Since  the  railroads 
secure  their  larger  return  only  because  of  the  greater 
traffic,  they  can  gain  from  lower  rates  only  by  making 
wheat  production  enough  more  profitable  to  insure 
larger  crops  and  more  exportation.  In  practice,  then, 
the  low  rates  can  be  profitable  to  the  railroads  as  a  whole 
and,  therefore,  to  the  nation  as  a  whole,  only  if  the  differ¬ 
ence  between  low  and  high  rates  on  exported  grain  goes 
in  part  to  American  producers,  and  not  entirely  to  foreign 
consumers. 

A  parallel  argument  may  sometimes  justify  lower  than 
average  rates  for  the  carriage  of  American  goods  pro¬ 
duced  in  the  interior  and  marketed  on  the  coast  or  other 
boundary,  when  these  goods  meet,  in  coast  or  border 
cities,  the  competition  of  like  goods  produced  abroad. 
So  long  as  these  lower  rates  cover  the  train  mileage  and 
terminal  expenses  occasioned,  and  something  towards 
general  expenses  or  profits,  American  railroads  can  better 
afford  to  carry  the  goods  than  not  to  carry  them. 
Interior  producers  and  border  consumers  may  both  be 
benefited. 

Discrimination  in  favor  of  exports  (or  of  interior-pro¬ 
duced  goods  marketed  on  the  border)  may  easily,  how¬ 
ever,  result  in  national  loss  to  the  country  whose  railroads 
thus  discriminate,  since  it  may  result  in  loss  to  the  rail¬ 
roads.  The  railroads  of  a  country,  acting  by  common 
council,  would  not  make  discriminating  reductions  in 
export  rates,  which  would  reduce  their  revenues.  But 
the  same  railroads,  acting  independently,  would  and  do 
make  such  reductions,  each  fearing  diversion  of  the  traffic 
to  its  rivals.  Each  one  dares  charge  only  what  the  traffic 
will  bear  without  being  diverted }  And  since  export  traffic 

1  See  Chapter  II  (of  Part  III),  §  6. 


152  TRANSPORTATION  COSTS  OF  COMMERCE 

is  peculiarly  subject  to  competition  of  routes,  what  the 
traffic  will  bear  without  being  diverted  may  be  very  low 
rates.  When  the  railroads  of  a  country  are  thus  com¬ 
pelled,  by  competition  with  each  other,  to  carry  export 
traffic  which  pays  less  than  its  proportionate  share 
towards  general  expenses  and  profits,  even  though  this 
traffic  might  be  made  to  pay  more  nearly  its  proportion¬ 
ate  share,  there  is,  in  effect,  a  bounty  given  to  this  export 
traffic.  In  the  long  run,  if  the  loss  to  railroads,  in  revenue 
from  carrying  goods  for  export,  is  extensive,  intermediate 
rates  must  be  higher,  since  railroads  will  not  be  built 
without  reasonable  prospects  of  gain.  But  higher  inter¬ 
mediate  rates  must  lessen  the  profits  of  internal  com¬ 
merce  and  tend  to  discourage  it.  We  have,  then,  a 
bounty  tending  to  encourage  exports,  but  imposing 
additional  expense  on  internal  trade,  and  so  turning 
productive  effort  out  of  the  channels  it  would  naturally 
seek,  into  other  and  presumably  less  profitable  channels.1 
If  the  low  export  rates  yield  more  towards  general 
expenses  and  profits  than  higher  ones  would  yield,  they 
are  not  analogous  to  a  bounty  or  bounties,  and  are  eco¬ 
nomically  desirable  from  the  standpoint  of  the  exporting 
country  (though  not  from  the  standpoint  of  other  coun¬ 
tries  producing  the  same  goods  and  competing  in  the 
same  markets) .  If  the  low  export  rates  yield  less  towards 
general  expenses  and  profits  than  higher  rates  would 
yield,  and,  at  the  same  time,  yield  less  than  their  pro- 

1  To  the  argument  that  such  discriminating  rates  might  benefit  the  producers 
of  wheat  more  than  they  would  injure  the  railroads  (the  latter  being  partly  com¬ 
pensated  by  larger  traffic)  and  might  thus  bring  an  average  gain,  it  is  to  be  an¬ 
swered  that  if  wheat  production  were  thus  made  more  profitable,  it  would  be 
earned  on  to  a  greater  extent,  until,  because  of  consequent  lower  prices  or  more 
intensive  cultivation,  or  both,  it  would  be,  at  the  margin,  little  or  no  more  prof- 
itable  than  the  taxed  and  discouraged  industries  at  the  expense  of  which  it  was 


DEFENSIBLE  PLACE  DISCRIMINATION  153 


portionate  share  towards  these  expenses  and  profits,  their 
lowness  amounts  to  a  bounty  or  bounties,  and  is  eco¬ 
nomically  undesirable.  It  is  probable  that  only  in  rare 
cases  will  discriminatingly  low  rates  in  favor  of  export 
traffic  actually  yield  more  net  revenue  to  the  railroads 
as  a  whole,  than  reasonable  but  not  discriminatingly  low 
rates  would  yield.  It  is  probable,  therefore,  that  dis¬ 
crimination  in  favor  of  exports  (or  in  favor  of  goods  carried 
to  border  cities  where  the  competition  of  foreign  goods 
is  met)  is  seldom  economically  desirable. 

On  the  other  hand,  exceptionally  high  rates  on  exported 
goods  are  to  some  extent  comparable,  in  their  economic 
effects,  to  high  export  duties.  If  the  goods  exported  are 
goods  which  foreigners  can  get  nowhere  else,  the  burden 
of  the  high  rates  may  be  borne  largely  by  them  and 
lower  rates  than  would  otherwise  be  charged  may  be 
thus  made  possible  on  other  traffic.  But  usually  the 
goods  can  be  secured  elsewhere,  and  the  high  rates  are 
likely  to  act  like  a  high  restrictive  export  tariff,1  in  divert¬ 
ing  the  industry  of  the  exporting  country  away  from  the 
most  profitable  into  less  profitable  lines. 

§  7 

Discriminations  between  Directions 

We  have  now  to  consider  a  kind  of  discrimination  of  a 
somewhat  different  class  from  the  discriminations  which 
we  have  so  far  discussed,  viz.,  discrimination  between 
two  opposite  directions.  Goods  are  frequently  carried, 
both  by  rail  and  water,  more  cheaply  in  one  direction  than 
the  other.  The  principal  reason  for  this  discrimination 
is  an  excess  of  freight  moving  one  way,  compared  with 


1  See  Part  II,  Chapter  IV,  §  3. 


154  TRANSPORTATION  COSTS  OF  COMMERCE 


the  movement  the  other.  Freight  moving  from  terri¬ 
tory  where  industry  is  chiefly  of  the  extractive  kind 
usually  has  large  bulk  in  proportion  to  its  value.  The 
equivalent  value  in  higher  grade  goods,  which  is  carried 
back  in  exchange,  occupies  less  space.  The  cars  (or 
vessels)  returning  may  not,  therefore,  be  loaded  to  their 
full  capacity.  Often  some  returning  cars  are  not  loaded 
at  all.  Yet  they  must  be  returned,  even  if  empty  or 
partially  so,  for  the  sake  of  the  outgoing  freight.  Since 
the  cars  have  to  be  taken  back,  anyway,  and  since, 
therefore,  the  additional  cost  to  the  railway  is  relatively 
little  greater  when  the  cars  are  loaded  (or  to  a  navigation 
company  when  the  vessels  are  loaded),  it  is  preferable 
to  carry  the  freight  for  a  low  charge,  rather  than  not  to 
carry  it  at  all.  If  there  is  private  monopoly  or  govern¬ 
ment  ownership,  the  excess  of  empty  cars  going  in  a  given 
direction  may  not  lead  to  discrimination  in  rates,  favoring 
that  direction,  though  it  is  likely  to  have  this  effect,  as 
to  some  of  the  business,  even  then ;  but  if  there  is  com¬ 
petition,  such  discrimination  will  certainly  be  practiced. 
The  return  trips  will  be  the  problem.  Each  company 
will  be  ready  to  make  very  low  rates,  if  necessary,  on  the 
back  hauls,  rates  which  do  not  even  cover  the  cost  of  the 
trips,  so  long  as  these  rates  more  than  cover  the  extra 
cost  of  moving  loaded  cars,  over  that  of  moving  empties ; 
for  otherwise  the  other  road  or  roads  will  get  the  business. 
The  freight  going  in  one  direction  may  so  tax  the  facili¬ 
ties  of  all  the  roads  that  rates  on  this  freight  will  be 
fairly  high  ;  while  the  scarcity  of  freight  to  be  carried  in 
the  opposite  direction,  relative  to  facilities,  will  induce 
intense  competition  and  make  rates  very  low.  So,  in 
ocean  transportation,  if  a  country  exports  a  large  quantity 
of  bulky  goods  and  imports  relatively  less,  outgoing  rates 


DEFENSIBLE  PLACE  DISCRIMINATION  155 


will  be  high,  and  rates  of  transportation  on  imports  low. 
In  the  opposite  situation,  a  country’s  imports  will  cost 
more  to  carry  and  its  exports  somewhat  less.1 

It  is  economically  desirable,  on  the  whole,  that  such 
discrimination  should  take  place.  It  cannot  be  said  that 
discrimination  in  directions  is  arbitrary  or  in  violation 
of  the  principles  of  cost.  For  the  cars  (or  ships)  would 
have  to  be  taken  to  destination  and  back  again,  even  if 
freight  moved  in  but  one  direction.  If  some  freight 
can  be  got  to  move  the  other  way,  it  must  be  admitted 
that  part  of  the  cost  —  so  much  as  would  be  required  to 
return  the  cars  empty  —  is  joint,  or  even  pertains  to  the 
movement  in  the  direction  of  the  bulkier  traffic.  It 
would  have  to  be  met  anyway,  and  cannot  properly  be 
said  to  be  due  to  the  taking  of  return  freight.  Freight 
moving  in  the  direction  which  the  empty  cars  have  to 
take  should  be  carried  at  rates  little  above  the  difference 
between  the  cost  of  hauling  the  cars  empty  and  the  cost 
of  hauling  them  full,  plus  terminal  expenses,  etc.,  rather 
than  to  be  refused.  Not  to  carry  such  freight  is  to  waste 
labor  and  facilities  which  might  be  utilized,  and  to  leave 
less  than  it  might  be,  the  total  national  wealth.  On  the 
other  hand,  freight  moving  in  the  opposite  direction,  to 
the  extent  that  it  involves  hauling  cars  (or  taking  ships) 
which  must  return  empty,  really  imposes  upon  the  labor 
force  of  the  community  the  cost  of  hauling  the  cars  both 
ways,  and  should  not  be  taken  at  rates  less  than  sufficient 
to  cover  this  cost.  Otherwise,  freight  may  be  carried 
for  less  gain  to  the  community  than  it  imposes  cost  upon 
the  community.  If,  therefore,  there  is  so  much  freight 
ready  to  go  in  one  direction  even  at  rates  which  pay 

1  Cf.  J.  R.  Smith,  The  Organization  of  Ocean  Commerce,  Philadelphia  (Publi¬ 
cations  of  the  University  of  Pennsylvania),  1905,  p.  17. 


156  TRANSPORTATION  COSTS  OF  COMMERCE 

enough  to  cover  the  return  haul  of  the  cars  empty,  that 
returning  freight  cannot  be  secured  at  the  mere  addi¬ 
tional  cost  of  hauling  loaded  cars,  to  fill  these  empties, 
then  no  freight  ought  to  be  taken  in  the  direction  of  the 
denser  traffic,  which  will  not  cover  the  return-of-cars 
cost,  nor  can  be  so  taken  without  risk  of  economic  waste. 
So  far  as  discrimination  of  directions  causes  a  greater 
equalization  of  opposite  flows,  it  serves  to  utilize  more 
fully  the  facilities  which  are  utilized  at  all,  without  pro¬ 
portionately  increased  expense,  and  so  makes  the  national 
capital  and  labor  force  more  productive. 

§  8 

Summary 

In  this  chapter  our  concern  has  been  mainly  with 
discrimination  between  places,  in  so  far  as  this  discrim¬ 
ination  can  be  defended,  on  economic  grounds,  as  con¬ 
ducing  to  national  prosperity.  We  saw,  first,  that  dis¬ 
crimination  by  a  roundabout  line  in  favor  of  through 
traffic  and  against  intermediate  traffic,  might  be  eco¬ 
nomically  defensible.  It  may  be  the  truest  economy 
that  some  of  the  through  traffic  should  go  by  a  round¬ 
about  line,  yet  this  through  traffic  is  entitled  to  rates  as 
low  as  a  more  direct  line  could  profitably  make.  Also, 
though  the  roundabout  line  cannot  always  afford  to 
make  correspondingly  low  rates  on  intermediate  traffic, 
it  may  be  to  the  advantage  of  intermediate  cities  on  its  line 
that  it  should  take  the  through  traffic  at  rates  which  at 
least  help  pay  general  expenses  and  profits.  The  pos¬ 
sibility  of  getting  part  of  the  competitive  traffic  encour¬ 
ages  the  building  of  roundabout  lines  which  bring  inter¬ 
mediate  points  into  touch  with  the  competitive  points. 


DEFENSIBLE  PLACE  DISCRIMINATION  157 


But  when  charges  on  competitive  traffic  are  so  low  as 
to  necessitate  discrimination  against  intermediate  traffic 
on  direct  roads  as  well  as  indirect,  there  is  economic 
waste,  and  competitive  points  are  receiving  advantages 
to  which  they  are  not  properly  entitled.  If  government 
regulation  is  to  attempt  to  raise,  in  this  regard,  the  plane 
of  competition,  the  ideal  is  to  prohibit  discrimination 
against  intermediate  points  on  direct  roads,  while  allow¬ 
ing  roundabout  roads  to  discriminate  to  a  limited  degree. 
The  aim  should  be  so  to  balance  the  limitations  on  com¬ 
peting  roads  as  not  to  interfere  with  the  economical 
routing  of  freight  or  with  the  building  of  roundabout 
lines  in  cases  where  these  are  more  needed.  In  no  case 
should  a  roundabout  line  be  allowed  to  carry  competitive 
traffic  for  less  than  the  additional  cost  involved,  or  to 
make  rates  on  non-competitive  traffic  so  high  as  to  get 
more  than  a  reasonable  return,  from  that  traffic  alone, 
on  the  capital  required  for  it.  In  many  cases  the  dis¬ 
crimination  allowed  to  the  roundabout  line  should  be 
much  less.  The  carrying  of  a  part  of  import  and  export 
traffic  by  roundabout  routes  may  be  defended  as  not 
economically  bad,  even  though  it  involves  relatively 
discriminating  rates  by  these  longer  routes  in  favor  of 
import  and  export  freight. 

But,  on  the  other  hand,  if  traffic  on  a  direct  road  is 
relatively  light,  so  that  its  average  rates  must  be  high, 
while  a  more  roundabout  road  has  heavy  traffic  and  low 
rates,  the  direct  road  may  be  the  one  which  should  be 
allowed  to  discriminate  in  order  that  it  may  carry  a  share 
of  competitive  traffic. 

Discriminating  rates  by  a  railroad  or  railroads  may 
be  justifiable  in  cases  where  the  low  rates  favor  points 
competitive  with  water  lines  as  against  points  situated 


158  TRANSPORTATION  COSTS  OF  COMMERCE 


on  rail  lines  only.  The  railroad  plant  is  desired  for  the 
intermediate  traffic  alone.  The  additional  cost  of  carry- 
ing  competitive  traffic  which  could  go  by  water  may  be 
so  little  that  it  is  more  economical  to  carry  it  by  rail  than 
to  construct  the  additional  ships  necessary  to  carry  it. 
A  consideration  of  the  effect  of  this  discrimination,  on  the 
various  interests  concerned,  strengthened  our  conclusion 
that  such  discrimination  might  often  be  defensible  and 
even  desirable.  Its  practice  is  seen  in  the  case  of  trans¬ 
continental  rates  made  by  American  railroads,  favoring 
coast  to  coast  and  nearly  coast  to  coast  transportation 
as  against  intermediate.  But  a  railroad  which  carries 
goods  for  less  than  the  bare  additional  cost  of  so  doing, 
in  order  to  ruin  a  competitor  by  water,  is  engaged  in 
illegitimate  competition. 

Discrimination  may  sometimes  be  practiced  with  desir¬ 
able  results  in  favor  of  transportation  which  is  competi¬ 
tive  with  local  self-sufficiency.  If  goods  can  be  carried  to 
a  given  point  and  sold  there  for  less  than  the  cost  of  local 
production,  there  is  a  saving,  even  though  these  goods 
pay  very  little  more  than  the  special  cost  incident  to 
their  transportation,  i.e.  even  though  they  contribute 
very  little  towards  general  expenses  and  profits.  If  the 

plant  is  there,  it  is  better  to  utilize  it  on  these  terms  than 
not  to  utilize  it. 

The  total  wealth  and  income  of  a  nation  may  be 
increased,  under  certain  circumstances,  if  its  railroads 
discriminate  in  favor  of  export  traffic,  or,  likewise,  in  favor 
of  traffic  to  border  cities  where  the  competition  of  im¬ 
ported  goods  is  met.  Such  discrimination  is  advanta¬ 
geous  when  the  lower  rates  yield,  for  native  railroads  taken 
as  a  whole,  so  much  larger  traffic  than  higher  rates,  as  to 
make  the  net  earnings  of  transportation  greater.  To 


DEFENSIBLE  PLACE  DISCRIMINATION  159 


thus  increase  the  export  business  of  the  railroads,  the 
lower  rates  must  yield  some  benefit  to  producers  for 
export.  So  far  as  diversion  of  the  goods  to  a  foreign 
market  raises  domestic  prices  of  those  goods,  domestic 
producers  gain  as  much  as  domestic  consumers  lose. 
There  is  a  net  national  gain,  though  rival  producing 
countries  may  lose.  But  when  competition  between  a 
country’s  railroads  brings  discrimination  in  favor  of  ex¬ 
port  traffic  which  would  otherwise  yield  larger  returns, 
the  discrimination  amounts  to  a  bounty  on  exports  at 
the  expense  of  the  railroads  and,  perhaps,  ultimately, 
at  the  expense  of  other  trade.  Industry  is  turned  from 
more  to  less  desirable  channels.  Discrimination  against 
exports,  unless  the  exporting  country  is  the  only  con¬ 
siderable  source  of  supply,  is  likely  to  interfere  with  a 
profitable  export  trade,  and  turn  the  nation’s  industry 
into  less  profitable  lines. 

Discrimination  between  two  opposite  directions  may 
result  from  an  excess  of  bulky  traffic  moving  in  one  direc¬ 
tion,  over  that  moving  in  the  reverse  direction.  This 
discrimination  is  economically  desirable,  within  reason¬ 
able  limits,  since  it  causes  fuller  utilization  of  the  facil¬ 
ities  required.  When  cars  (or  vessels)  must  be  taken  to  a 
given  point,  whether  empty  or  full,  it  is  better  to  accept 
traffic  at  little  more  than  the  added  cost  of  taking  them 
full,  than  to  refuse  this  traffic. 


CHAPTER  VI 

Relative  Rates  on  Different  Goods 


§  i 


Why  Rates  on  Competing  Goods  should  he  in  Proportion 

to  Transportation  Cost 

Having  completed  our  discussion  of  local  discrimina¬ 
tion,  we  have  now  to  consider  discrimination,  if  we  may 
here  also  use  the  term,  in  the  rates  charged  for  carrying 
different  kinds  of  goods.  As  in  the  two  previous  chap¬ 
ters,  we  shall  apply  the  test  of  general  economic  welfare 
to  transportation  practices. 

It  is  not  always  easy  in  any  given  case,  perhaps  not 
always  possible,  to  decide  how  much  one  kind  of  goods 
should  be  charged,  relatively  to  the  charge  made  for 
carrying  other  kinds.  Nevertheless,  we  can  lay  down 
important  principles  to  which  the  relation  of  rates  should 
conform.  In  looking  at  the  matter  of  relative  rates 
among  different  goods,  from  the  point  of  view  of  general 
community  welfare,  the  following  principles  are  those 
which,  it  is  believed,  should  be  kept  particularly  in  view. 
In  the  first  place,  the  rates  charged  should  be  such  as 
will,  all  things  considered,  get  industry  into  and  keep  it 
in  the  most  profitable  lines  or  channels.  Second,  the 
rates  charged  should  lead  to  the  most  economical  loca¬ 
tion  of  each  kind  of  industry.  In  the  third  place,  these 
rates  should  be  the  ones  which  will  result  in  the  com- 


RATES  ON  DIFFERENT  GOODS 


161 


pletest  profitable  utilization  of  the  transportation  plant. 
Let  us  consider  these  principles  in  this  order. 

That  industry  may  be  kept,  on  the  whole,  in  the  most 
profitable  lines,  some  regard  must  be  had,  in  carrying 
goods,  to  the  cost  of  carrying.  A  transportation  com¬ 
pany  will  naturally  consider  costs  of  carriage  in  fixing 
its  rates,  even  though  part  of  these  costs  cannot  be 
allocated.  At  least  it  will  refuse  to  transport  any 
goods,  during  any  considerable  period,  for  less  than 
the  special  or  additional  cost  incident  to  carrying 
them.  Many  things  will  pay  more.  But  nothing  will 
pay  less.  Cost  of  transportation  is,  therefore,  one  ele¬ 
ment  in  fixing  the  relative  charge  on  different  kinds  of 
goods. 

Under  the  head  of  cost  come  many  special  considera¬ 
tions,  for  example,  the  hazardous  nature  of  the  service. 
Upon  such  articles  as  gunpowder,  dynamite,  nitro¬ 
glycerine,  etc.,  higher  rates  are  likely  to  be  charged  than 
upon  many  articles  of  similar  size,  weight,  and  value, 
which  are  non-explosive.  Not  only  may  the  explosives 
themselves  be  destroyed  in  transit,  but  they  may  de¬ 
stroy  other  property.  The  greater  risk  in  carrying  them 
is  in  the  nature  of  a  cost. 

Space  occupied,  or  size  and  bulk  of  freight  carried,  is 
another  factor  in  cost.  Even  if  the  goods  to  be  carried 
are  extremely  light,  the  fact  that  they  require  large 
space  necessitates  the  use  of  cars  in  perhaps  consider¬ 
able  numbers.  This  means  that  a  considerable  weight 
of  trucks,  car  floors,  walls,  etc.,  must  be  carried  to  accom¬ 
modate  the  freight.  It  means,  also,  that  the  car  repair 
account  will  be  larger,  as  well  as  that  more  cars  are  re¬ 
quired  on  which  interest  should  be  earned.  It  follows 
that  space  occupied  determines,  in  part,  the  cost  of 


PART  in  —  M 


162  TRANSPORTATION  COSTS  OF  COMMERCE 

carriage.  The  weight  of  goods  to  be  carried  is,  of 
course,  also  a  factor  in  cost,  and  tends  to  affect  the 
rates  charged.  Goods  which  are  liable  to  spoil  in 
transit,  or  which,  for  any  other  reason,  require  special 
care,  cost  more  to  carry.  All  these  elements  should 

and  largely  do  influence  railroad  officials  in  their  classi¬ 
fications  of  freight. 

A  special  case  is  found  in  the  shipment,  on  water 
routes,  of  goods  which  can  be  used  as  ballast.  Such 
goods  serve,  in  part  at  least,  as  an  assistance  (by  steady¬ 
ing  ships)  in  the  carriage  of  other  goods.  By  so  doing 
they  may  be  said  to  partly  pay  their  own  cost  of  trans¬ 
portation,  and  the  uet  cost  of  carrying  them  may  be 
said  to  be  low.  A  low  rate  of  transportation  can,  there¬ 
fore,  be  afforded  by  ship-owning  companies  on  such 

goods.  British  coal  is  said  to  be  thus  carried,  as  ballast 
cargo,  at  low  rates.1 

The  principle  that  rates  should  be  such  as  to  keep 
industrial  effort  in  the  channels  most  profitable  to  the 
community  requires  that  rates  on  different  commodities 
shall  be  in  reasonable  proportion  to  cost  of  carrying, 
whenever  these  commodities  can  be  regarded  as  com¬ 
peting  goods,  i.e.  as  goods  which  may  be  substituted  for 
each  other  by  consumers  or  other  purchasers.  Examples 
are  Pearline  and  laundry  soap,2  Wheatena  and  Cream 
of  Wheat,  brick  and  stone  for  building.  It  will  be  seen 
that  if  the  cost  of  carriage  is  the  same,  a  higher  charge 
for  carrying  stone  than  for  carrying  brick  may  involve 
economic  waste,  since  it  may  cause  brick  to  be  used  for 
building  in  places  where  stone  would  be  on  other  accounts 

1 J.  R.  Smith,  The  Organization  of  Ocean  Commerce,  Philadelphia  (Publica¬ 
tions  of  the  University  of  Pennsylvania),  1905,  p.  17. 

2  Sec  Interstate  Commerce  Commission  Reports,  Vol.  I,  pp.  465-479, 


RATES  ON  DIFFERENT  GOODS  163 

more  desirable.  If  the  higher  rates  merely  paralleled  a 
higher  labor  cost  of  transportation,  uneconomy  could 
not  be  alleged,  since  these  rates  would  but  bring  to  the 
attention  of  builders  a  real  economic  disadvantage  of 
using  stone.  Without  the  higher  rates,  the  public 
would  be  unduly  encouraged  to  use  materials  which,  in 
so  far  as  transportation  is  concerned,  cost  more  than 
others.  But  if  the  economic  disadvantage  does  not  exist, 
rates  which  make  it  seem  to  exist,  and  which  make 
men  act  as  if  it  existed,  are  economically  bad.  The  de¬ 
cision  what  to  use  among  competing  goods,  and  there¬ 
fore  how  much  of  each  kind  of  such  goods  should  be 
produced,  and,  therefore,  the  lines  of  production  which 
industry  should  follow ,  ought  to  be  determined  on  the 
basis  of  all  the  advantages  and  disadvantages  of  each 
kind  of  such  goods,  including  cost  of  production  and  cost 
of  carriage.  In  order  that  all  of  these  elements  may 
enter  properly  into  the  consideration  of  the  users,  and 
so  exercise  their  due  influence  on  the  lines  of  activity  of 
the  producers,  the  users  should  be  charged  for  each 
kind  of  goods  proportionately  to  the  actual  labor  (and 
waiting)  costs,  including  transportation,  of  providing  them 
with  the  goods,  just  as  the  consumers  realize  gains  from 
these  goods  proportionately  to  the  serviceability  of  each. 
Section  3  of  the  Interstate  Commerce  Law  prohibits  un¬ 
due  discrimination  not  only  in  favor  of  any  locality  or 
person  but  also  in  favor  of  any  particular  description  of 
traffic.  In  determining,  in  any  specific  case,  whether 
the  discrimination  complained  of  is  undue,  the  Inter¬ 
state  Commerce  Commission  does  not  fail  to  consider 
the  competitive  relations  of  the  goods  discriminated 
against.1 


* Ibid . 


1 64  TRANSPORTATION  COSTS  OF  COMMERCE 

§  2 

The  Proper  Relation  oj  Rates  on  Finished  Products  to 

Rates  on  Raw  Materials 

In  order  that  there  may  be  the  most  economical  loca¬ 
tion  of  different  manufacturing  industries,  regard  must 
be  had  to  the  relative  charges  on  raw  material  and  on 
finished  product.  For  example,  consider  the  rates  on 
wheat  compared  with  those  on  flour  and  the  rates  on 
lumber  compared  with  those  on  furniture.  If  the  trans¬ 
portation  charge  on  wheat  from  the  West  were  much 
lower  than  the  charge  for  transporting  flour,  then  all 
the  milling  of  flour  for  eastern  use  would  be  done  in  the 
East.  In  the  Export  Rate  case,1  it  was  shown  that  the 
rate  on  wheat  for  export  was  considerably  lower  than 
on  flour.  This  would  tend  to  stimulate  milling  abroad, 
since  it  would  be  cheaper  to  pay  the  low  rate  on  wheat 
than  the  high  rate  on  flour.  On  the  other  hand,  a  much 
lower  rate  on  flour  than  on  wheat  from  the  West 
would  perhaps  ruin  eastern  millers  and  cause  flour  to  be 
manufactured  almost  entirely  near  the  wheat  fields. 
The  milling  should  be  done,  of  course,  where  all  the  facili¬ 
ties  and  conditions,  including  actual  labor  cost  of  trans¬ 
porting  the  wheat,  and  cost  of  transporting  the  flour, 
are  the  most  favorable  in  relation  to  the  facilities  and 
conditions  for  other  industries.  The  transportation 
companies  should  not  unreasonably  discriminate  in  favor 
of  either  the  wheat  or  the  flour.  Flour  has  more  value, 
and  may,  therefore,  involve  greater  risk  of  loss.  Pos¬ 
sibly  the  cost  of  carrying  may  be  greater.2  It  may  be 
permissible  that  the  charge  for  transporting  flour  should 

1  Interstate  Commerce  Reports,  Vol.  VIII,  pp.  214-276. 

2  Ibid.  pp.  244-246. 


RATES  ON  DIFFERENT  GOODS  165 

be  somewhat  greater  than  the  charge  for  transporting 
wheat.  But  if  so,  it  should  be  greater  only  to  the  extent 
that  such  special  facts  justify.  Such  is  the  position 
which  the  Interstate  Commerce  Commission  takes  in 
applying  the  law  to  specific  cases.1 

Perhaps  a  sharper  distinction  between  raw  material 
and  finished  product  is  found  in  the  case  of  lumber  and 
furniture.  Furniture  is  much  more  valuable  and  is  more 
liable  to  breakage.  It  occupies,  generally,  more  space  in 
proportion  to  its  weight.  A  higher  charge  on  the  furni¬ 
ture  is  therefore  entirely  proper.  But  the  relation  be¬ 
tween  the  charges  for  lumber  and  furniture  transpor¬ 
tation  should  not  be  more  favorable  to  lumber  than  such 
considerations  warrant. 


When  Rates  may  Properly  be  Lower  on  Some  Kinds  of 

Goods  than  on  Others ,  in  Relation  to  Cost  of  Carriage 

We  have  now  to  give  attention  to  the  third  test  of 
relative  rates  charged  for  carrying  different  goods,  viz., 
the  question  of  completest  utilization  of  transportation 
plant.  The  desirability  of  utilizing  transportation  plant 
as  completely  as  possible  may  justify  a  lower  rate  on 
the  product  of  one  industry  than  on  the  product  of  an¬ 
other,  even  though  the  special  or  additional  cost  inci¬ 
dent  to  carrying  them  is  the  same  for  both.  For  the  one 
kind  of  goods  may  require  a  low  rate  in  order  that  it 
shall  be  carried  at  all  for  any  great  distances,  while  the 
other  kind  may  be  able  to  pay  a  higher  rate.  Thus,  *a 
high  rate  to  a  given  place,  on  goods  which  could  be  pro¬ 
duced  locally,  would  mean  that  the  transportation  com- 


1 Ibid . 


1 66  TRANSPORTATION  COSTS  OF  COMMERCE 

pany  charging  such  rates  might  get  no  traffic  at  all  in 
those  goods,  whereas  it  could  charge  reasonably  high 
rates  upon  goods  which  had  to  be  secured  from  else¬ 
where,  without  sacrificing  traffic.1 

Even  some  goods  which  are  not  locally  producible 
may  have  to  be  brought  to  a  market  cheaply,  because 
otherwise  locally  produced  substitutes  will  be  used. 
The  rate  on  building  stone  carried  to  a  given  locality 
may  need  to  be  low  because  brick  can  be  produced  there, 
and  because,  consequently,  if  the  rate  on  building  stone 
is  not  low,  it  cannot  be  carried.  The  low  rate  makes 
possible  a  larger  total  traffic,  a  more  complete  utiliza¬ 
tion  of  transportation  plant ;  and,  therefore,  if  the  rate 
charged  pays  anything  above  the  special  cost  of  carry¬ 
ing,  the  traffic  is  worth  while.  It  is  better  that  some 
goods  should  be  carried,  even  at  less  than  average  rates, 
if  the  charge  amounts  to  something  over  the  special 
cost  of  carrying,  than  that  these  goods  or  substitutes  for 
them  should  be  produced  locally,  and  the  transportation 
plant  be  incompletely  utilized.  The  revenue  so  yielded 
to  transportation  companies  makes  possible,  if  they  will 
it  or  can  be  compelled  to  it,  lower  charges  for  the  carry¬ 
ing  of  other  goods,  than  they  could  else  afford;  or  it 
makes  possible,  because  profitable,  the  construction  of 
transportation  lines  which  otherwise  would  not  pay, 
and,  therefore,  makes  possible  transportation  service  for 
other  goods  also,  between  points  where  such  service 
would  not  otherwise  exist. 

An  analogous  argument  applies,  to  some  extent,  in  de¬ 
fense  of  low  rates  on  railroads  favoring  goods  which  are 
especially  likely  to  go  by  water.  For  if  a  railway  plant 
is  necessary,  anyway,  between  two  given  points,  and  is 

1  Cf.  Chapter  V  (of  Part  III),  §  5. 


RATES  ON  DIFFERENT  GOODS 


167 


desired  for  certain  kinds  of  through  traffic,  it  may  be 
better  to  use  it  for  some  other  through  traffic  also,  rather 
than  to  invest  additional  social  capital  in  ships.1 

There  is  nothing  in  the  above  conclusions  inconsistent 
with  the  conclusion  reached  earlier  in  the  chapter,  that 
arbitrary  discrimination  between  goods  is  uneconomical. 
Lower  rates  proportionate  to  special  cost  of  carriage, 
on  stone  for  example,  than  on  most  other  things,  have 
been  justified  only  if  they  increase  traffic  without  pro¬ 
portionately  increasing  cost.  Lower  rates  on  building 
stone,  proportionate  to  special  cost  of  carrying,  than  on 
brick,  between  two  given  points,  would  not  thereby  be 
justified,  since  such  a  relationship  of  rates  would  prob¬ 
ably  mean,  not  that  more  goods  would  be  transported, 
but  that  building  stone  would  be  carried  instead  of  brick. 
Lower  rates  on  both  than  on  most  other  goods,  necessi¬ 
tated  by  a  possibility  of  local  production  of  either,  would 
be  justified.  The  question  to  be  considered  in  each  case 
is  whether  total  traffic  is  considerably  increased,  or 
whether  freight  of  one  kind  is  substituted  for  freight  of 
another  kind.  In  some  cases,  of  course,  goods  are  used 
for  different  purposes,  but  are  substitutes  to  a  limited 
extent.  Rates  should  then  be  fixed  with  reference  to 
both  the  above  principles  and  with  a  view  to  a  balance 
of  advantages. 

Similarly  in  the  case  of  relative  charges  on  raw  ma¬ 
terial  and  finished  product.  Except  in  so  far  as  there 
may  be  non-transportable  waste,  discrimination  in  favor 
of  either  cannot  be  expected  to  result  in  larger  total 
traffic,  but  only  in  traffic  of  one  kind  instead  of  traffic 
of  another  kind.  High  rates  on  flour  mean  that  wheat 
will  be  transported  instead.  High  rates  on  wheat  mean 

1  / bid.,  §  4. 


1 68  TRANSPORTATION  COSTS  OF  COMMERCE 

that  flour  will  be  transported  instead.  The  situation  is 
complicated,  of  course,  in  the  case  of  certain  materials, 
such  as  leather,  which  are  raw  material  for  many  dif¬ 
ferent  articles,  e.g.  shoes,  suit  cases,  harness,  etc.  Since 
the  leather  is  raw  material  for  one  of  these  uses  only  to  a 
limited  extent,  the  transportation  rate  may  properly  be 
determined  in  part  by  other  considerations  than  its 
relation  to  a  single  finished  product. 

But  considerations  regarding  utilization  of  transpor¬ 
tation  plant  may  justify,  in  some  cases,  somewhat  lower 
rates  per  ton  on  raw  material  than  on  finished  goods, 
even  though  the  special  or  additional  cost  per  ton,  in¬ 
curred  because  of  carrying  the  raw  material,  is  no  less. 
Suppose  that,  in  the  production  of  certain  kinds  of 
finished  goods,  much  of  the  raw  material  necessarily 
goes  to  waste,  so  that  the  total  weight  of  material  is 
much  less  after  the  process  of  manufacture  is  complete. 
The  same  rate  per  ton  on  the  finished  goods  as  on  the 
raw  material  would  then  encourage  manufacture  of  these 
goods  near  the  source  of  the  raw  material,  instead  of 
near  markets  far  distant  from  the  raw  material.  A 
transportation  company  could,  however,  in  some  cases, 
well  afford  to  make  somewhat  lower  rates  per  ton  on 
the  raw  material,  if,  by  so  doing,  it  could  get  the  much 
larger  number  of  tons  to  carry.  The  result  would  be  a 
more  complete  utilization  of  transportation  plant  and  a 
greater  net  profit.  The  rate  on  raw  material  should  be 
high  enough  so  that,  if  more  of  it  has  to  be  transported, 
the  total  charges  would  be  greater  by  enough  to  cover 
the  greater  special  cost  of  its  transportation.  In  other 
words,  the  rate  on  the  raw  material  should  at  least  be 
high  enough  so  that  the  net  profit  from  its  transporta¬ 
tion  would  be  as  great  as  it  would  be  if  the  finished 


RATES  ON  DIFFERENT  GOODS 


169 


product  were  carried  instead.  Otherwise  the  manu¬ 
facturing  industry  served  would  tend  to  be  located  far 
from  the  raw  material,  at  the  expense  of  the  transporta¬ 
tion  line  and  at  a  greater  labor  cost  for  transportation, 
even  though  the  far  location  offered  no  advantages 
sufficient  to  counteract  this  loss.  If  the  manufacturing 
industry  itself  had  to  bear  this  transportation  labor  cost 
in  the  freight  rates  it  paid,  it  would  not  locate  far  from 
the  raw  material  needed,  except  for  compensating 
advantages.  But  to  make  the  charge  for  transporting 
raw  material  as  great  per  ton  as  for  transporting  the 
finished  product,  when  to  do  so  means  to  get  a  less  total 
traffic,  may  unduly  stimulate  the  location  of  manufac¬ 
turing  near  the  raw  material  under  circumstances  such 
that,  all  things  considered,  including  the  matter  of 
utilization  of  transportation  plant,  location  of  some 
factories  near  markets  far  away  from  the  source  of  raw 
material  would  be  more  economical. 

The  desirability  of  utilizing  the  transportation  plant 
is  the  consideration  which  justifies,  economically,  rela¬ 
tively  lower  rates  on  cheaper  goods  and  relatively  higher 
rates  on  more  valuable  goods,1  when  the  special  or 
additional  cost  of  carrying  them  (i.e.  terminal  and  train 
mileage  costs  incident  to  taking  them)  is  the  same  for 
both.  Valuable  goods  can  usually  be  charged  more  by 
bulk  or  by  weight,  without  the  price  of  these  goods  being 
raised  by  any  appreciable  per  cent.,  and,  therefore,  with¬ 
out  the  sale  of  the  goods  in  distant  markets  being  de¬ 
stroyed  or  seriously  limited.  But  rates  on  coal,  lumber, 
brick,  stone,  and  other  low-grade  goods  cannot  be,  for 

1  Hadley,  Railroad  Transportation,  New  York  (Putnam),  1885,  p.  112; 
Ripley,  Railroads,  Rates  and  Regulation,  New  York  (Longmans,  Green,  and 
Co.),  1912,  p.  no. 


170  TRANSPORTATION  COSTS  OF  COMMERCE 


shipments  over  long  distances,  correspondingly  high  per 
ton  mile.  If  they  are,  the  prices  of  the  goods  will  be 
raised  so  much  that  consumers  in  distant  markets  will 
supply  themselves  with  the  desired  goods  or  with  sub¬ 
stitutes  from  nearer  home,  and  the  railroad  transpor¬ 
tation  plant  may  not  be  as  fully  utilized  as  it  profitably 
might.  Ten  dollars  a  ton  for  transportation  to  a  given 
market,  added  to  the  price  of  shoes,  makes  little  differ¬ 
ence  to  the  average  purchaser  of  one  pair,  since  the  price 
of  one  pair  (supposing  it  to  weigh  two  pounds)  would 
have  to  be  greater  by  just  one  cent.  Nor  would  so 
slight  a  proportionate  addition  to  the  cost  of  getting  the 
shoes  from  a  distant  factory  be  likely  to  make  local 
production  preferable  where  other  industries  would 
otherwise  be  more  profitable.  But  ten  dollars  per  ton 
added  to  the  price  of  coal  would  very  greatly  diminish 
the  transportation  of  coal,  since  every  other  practicable 
method  of  getting  heat  or  power  would  be  likely  to  be 
resorted  to  in  preference  to  purchasing  coal  from  a  dis¬ 
tance  at  a  price  of  from  $12  to  $15  a  ton.  In  the  case  of 
low-grade  goods,  the  traffic  will  often  bear  but  a  low 
rate  without  being  destroyed.  In  the  case  of  high- 
grade  goods,  the  traffic  will  bear,  as  a  rule,  higher  rates.1 
An  addition  to  rates,  per  ton  or  per  carload,  does  not, 
within  wide  limits,  so  much  affect  the  total  transporta- 

1  The  view  that  competition  between  two  or  more  railroads,  by  putting  em¬ 
phasis  on  what  the  traffic  will  bear  without  being  diverted,  or,  as  the  writer  then 
phrased  it,  on  relative  responsiveness  of  traffic,  would  tend  to  keep  rates  on  valu¬ 
able  goods  about  as  low  in  relation  to  cost  of  carriage  as  on  cheaper  goods,  was 
set  forth  in  the  Yale  Review,  May,  1907,  in  an  article  on  The  Basis  of  Rate 
Making  as  Affected  by  Competition  versus  Combination  of  Railroads,  pp.  83-85. 
Cf.  Pigou,  Railway  Rates  and  Joint  Costs,  Quarterly  Journal  of  Economics, 
August,  1913,  p.  691.  But,  as  is  shown  in  the  text,  where  the  competition  is 
with  local  self-sufficiency  the  lower  grade  goods  are  likely  to  be  accorded  lower 
rates. 


RATES  ON  DIFFERENT  GOODS 


171 

tion  business.  It  is  desirable  that  the  transportation 
plant  should  be  fully  utilized,  so  far  as  it  can  be  without 
loss,  and  it  is  therefore  desirable  that  rates  on  low-grade 
goods  should  be  low  enough,  provided  not  unprofitable, 
to  get  the  business.  Considerations  of  profit  are  likely 
to  cause  railroad  companies  to  put  these  low-grade 
goods  into  the  lower  classes  of  freight,  on  which  the  rates 
are  most  reasonable,  or  even,  in  many  cases,  to  carry 
them  at  special  “commodity  rates”  instead  of  at  regular 
“class  rates.” 

It  may  be  added  that  the  practice  of  charging  more  for 
carrying  valuable  than  for  carrying  cheap  goods  is  not 
confined  to  railroads  but  is  observable  also  in  water 
transportation  on  regular-line  vessels,1  since  these  vessels 
carry  cargoes  made  up  of  many  different  kinds  of 
goods. 

But  the  question  may  arise,  how  the  relation  of  rates 
charged  for  the  transportation  of  different  kinds  of 
goods  should  be  fixed,  if  the  profits  of  a  transportation 
company  are  excessive  and  the  public  is  entitled  to  a 
lower  average  of  rates.  Should  there  be  a  blanket  re-* 
due  tion  applying  to  all  goods  equally,  or  should  some 
rates  be  reduced  more  than  others,  or  should  some  rates 
be  reduced  and  others  not  ? 

Let  us  suppose  that  the  profits  on  the  capital  invest¬ 
ment  of  a  certain  railroad  are  20  per  cent,  a  year  and 
that  it  is  thought  just  to  reduce  rates  and,  therefore, 
profits,  by  public  authority.  We  may  assume  that  the 
only  goods  carried  by  this  railroad  are  wheat  and  coal, 
that  the  rates  charged  on  each  are  the  rates  yielding 
the  largest  net  returns,  and  that  the  traffic  offered  at 
those  rates  does  not  fully  utilize  the  railroad  plant. 

1 J.  R.  Smith,  The  Organization  of  Ocean  Commerce,  p.  46. 


172  TRANSPORTATION  COSTS  OF  COMMERCE 


The  question  then  is  :  on  what  goods  and  to  what  extent 
shall  reduction  be  required?  It  may  be  that  a  reduc¬ 
tion  in  the  rate  charged  for  carrying  wheat,  of  io  per 
cent.,  would  increase  the  traffic  in  wheat  by  but  i  or  2 
per  cent.,  whereas,  a  reduction  in  the  rate  charged  for 
carrying  coal,  of  10  per  cent.,  would  increase  the  coal 
traffic  by  8  per  cent.  Obviously  a  10  per  cent,  reduction 
can  then  be  required  on  coal  without  so  greatly  decreas¬ 
ing  the  railroad’s  net  profits  as  if  the  reduction  were 
required  on  wheat.  Or  a  greater  reduction  can  be  re¬ 
quired  on  coal  than  on  wheat,  without  occasioning  cor¬ 
respondingly  greater  loss  to  the  railroad.  The  public 
may  derive  a  larger  gain  and  the  railroad,  at  the  same 
time,  suffer  no  larger,  and  perhaps  a  smaller,  loss  of  net 
revenue.  A  part  of  the  gain  of  shippers  and  consumers 
is  at  the  expense  of  the  railroad,  but  a  part  of  it  flows 
from  the  fuller  utilization  of  railroad  plant  and  so  repre¬ 
sents  a  net  economic  gain  to  the  community.  Such  an 
adjustment  of  rates  might,  therefore,  be  not  undesirable. 
But  the  coal  should  under  no  circumstances  be  carried 
at  a  loss,  for  that  would  encourage  transportation  not 
worth  its  cost.  Nor  should  rates  on  wheat  be  higher 
than  would  pay  a  fair  return  on  the  railroad  plant  and 
equipment  necessary  to  transport  the  wheat  only,  for 
that  would  involve  an  arbitrary  taxation  of  wheat 
shippers  and  consumers  in  favor  of  shippers  and  con¬ 
sumers  of  coal.  It  may,  perhaps,  be  justifiable  that  the 
advantages  of  the  larger  scale  transportation  should 
show  themselves  entirely  in  the  reduced  coal  rates.  But 
it  would  not  be  justifiable  to  make  the  wheat  rates 
higher,  because  coal  traffic  is  also  available,  than  if 
wheat  alone  could  be  carried. 

On  the  other  hand,  if  the  railroad  plant  in  question  is 


RATES  ON  DIFFERENT  GOODS 


m 


already  pretty  fully  utilized  when  it  is  proposed  to  re¬ 
duce  rates,  and  cannot  accommodate  much  more  traffic, 
the  reduction  may,  perhaps,  no  less  advantageously  be 
made  on  the  wheat.  At  any  rate,  increased  coal  traffic 
should  not  be  developed  at  rates  lower  than  would  pay 
reasonable  returns  on  any  additional  plant  thus  made 
necessary. 

It  is  obvious  that  similar  considerations  may  deserve 
attention  when  the  railroads  propose  rate  advances  and 
seek  the  consent  of  the  Interstate  Commerce  Commis¬ 
sion  to  put  such  proposed  advances  into  effect.1 

Whether  voluntary  or  forced,  a  special  rate  reduction 
on  favored  goods  is  only  justifiable  if  total  traffic  is  thus 
increased.  A  reduction  in  the  charge  for  carrying  stone 
from  a  quarry  to  market  might  be  economically  defen¬ 
sible  if  it  meant  less  community  self-sufficiency,  more 
persons  engaged  in  producing  for  a  distant  market,  con¬ 
sequent  greater  total  trade,  and  more  transportation. 
But  economic  justification  would  be  lacking  if  the  re¬ 
sult  of  the  reduction  was  that  the  quarry  company, 
instead  of  adding  to  the  total  transportation  business  of 
the  reducing  railroad,  merely  drew  into  its  quarries  the 
sons  and  hired  men  of  neighboring  farmers,  who  would 
otherwise  be  devoting  their  entire  labor  time  to  provid¬ 
ing  the  railroad  with  traffic  in  wheat.  In  such  a  case, 
discriminating  reduction  would  tend  to  divert  the  in¬ 
dustrial  effort  of  the  locality  concerned,  from  more  to 
less  desirable  channels.  The  reduction,  if  desirable, 
should  then  be  general  and  not  discriminating. 

1  See  Bauer,  Returns  on  Public  Service  Properties,  Political  Science  Quarterly, 
March,  1915,  pp.  106-133,  especially  pp.  116,  117. 


174  TRANSPORTATION  COSTS  OF  COMMERCE 


§4 


Summary 

We  conclude,  then,  that  discrimination  between  dif¬ 
ferent  kinds  of  goods  should  not  be  arbitrary,  but  may, 
under  certain  circumstances,  be  economically  defensible. 
When  goods  are  competitive,  higher  rates  should  not  be 
charged  for  carrying  one  kind  the  same  distance  and  to 
the  same  market  as  another  kind,  unless  the  actual 
transportation  cost  is  greater,  since  such  discrimination 
in  rates  tends  to  divert  industry  from  a  more  into  a  less 
profitable  channel.  Neither  should  arbitrary  discrimina¬ 
tion  between  raw  materials  and  finished  products  be 
allowed  to  force  manufacturing  industries  into  locations 
where  there  is  relative  uneconomy  of  labor.  But  lower 
rates  on  some  goods  than  on  others  may  be  justified  in 
certain  cases  where  the  above  evils  are  not  likely  to 
result,  and  where  more  complete  utilization  of  the  trans¬ 
portation  plant  is  thus  secured.  And  in  reducing  rates 
when  profits  are  unduly  high,  regulating  bodies  may, 
with  propriety,  give  attention  to  the  probable  effects 
on  traffic  of  reductions  in  the  charges  for  carrying 
different  kinds  of  goods. 


CHAPTER  VII 


Discrimination  among  Shippers 


Methods  of  Practicing  and  of  Concealing  Discrimination 

among  Shippers 


Having  discussed  discrimination  among  different 
places  and  among  different  kinds  of  goods,  we  have 
next  to  consider  discrimination  among  different  shippers, 
among  different  persons,  or  corporations.  This  kind  of 
discrimination  has  been,  with  the  railroads  of  the  United 
States,  very  common,  and  as  a  matter  of  fact,  is  still  in 
some  degree  practiced.  Yet  it  is  pretty  generally  ob¬ 
jected  to  as  unfair,  is  perhaps,  of  all  kinds  of  discrimina¬ 
tion,  most  repugnant  to  the  ideals  of  a  democratic  people, 
and  is,  for  American  railroads,1  definitely  illegal  and 
punishable.  Discrimination  among  shippers  is  prac¬ 
ticed  also  to  some  extent  in  ocean  transportation  by 
regular-line  vessels.2  The  conditions  tending  to  produce 

1  Or  a  railroad  and  a  water  line  when  they  are  operated  “under  a  common 
control,  management,  or  arrangement  for  a  continuous  carriage  or  shipment.” 

2Huebner,  Report  on  Steamship  Agreements  and  Affiliations  in  the  American 
Foreign  and  Domestic  Trade,  in  Proceedings  of  the  Committee  on  the  Merchant 
Marine  and  Fisheries  in  the  Investigation  of  Shipping  Combinations,  1914,  Vol. 
IV,  pp.  236,  237- 

As  the  time  for  sailing  draws  near,  a  line  vessel  will  sometimes  accept  very  low 
rates  rather  than  start  with  a  very  small  cargo,  while  it  will  charge  fairly  high 
rates  if  its  space  is  nearly  taken.  It  may  charge  different  rates  to  the  very  same 
person  on  different  consignments  of  goods.  (See  Interstate  Commerce  Reports, 
Vol.  XI,  p.  24.)  This,  in  itself,  is  not  objectionable.  Persistent  and  intentional 
favoritism  is  so.  (See  §  4  of  this  Chapter,  VII  of  Part  III.) 

*75 


176  TRANSPORTATION  COSTS  OF  COMMERCE 


discrimination  among  shippers  are  hardly  to  be  found 
in  the  case  of  charter  traffic.  Competition  of  tramp 
vessels  insures  reasonable  rates  to  all  shippers  or  groups 
of  shippers  able  to  charter  a  vessel ;  and  one  shipper 
would  not  often  be  favored,  intentionally,  with  low 
charter  rates,  so  long  as  others  were  ready,  singly  or 
jointly,  to  charter  the  same  vessel  and  pay  higher  rates. 
Perhaps  for  this  reason  there  has  been  more  of  a  tend¬ 
ency  to  let  competition  on  waterways  take  its  course 
unregulated,  though  the  evidences  seem  to  be  increasing 
that  regular-line  companies  are  comparable,  in  many 
respects,  to  railroad  companies,  are  similarly  subject  to 
monopoly  control,  though  perhaps  not  to  the  same  de¬ 
gree,  and  may  need  to  have  their  practices  investigated 
with  a  view  to  regulation. 

The  popular  opposition  to  discrimination  among 
shippers,  and  the  fact  that  legislation  has  forbidden 
railroads 1  to  practice  it,  combined  with  a  frequent  wish 
that  rival  transportation  companies  should  not  know 
what  is  being  done,  have  caused  discriminating  rates  to 
be  given  and  received  in  underhanded  and  evasive  ways. 
In  such  ways  the  Standard  Oil  Company  seems  to  have 
received  transportation  rate  favors  in  recent  years. 
Thus,  it  was  shown  by  a  government  report 2  in  1906, 
that  this  company  was  advantaged  by  lower  rates  made 
from  points  where  it  alone  had  refineries  than  from  points 
where  there  were  refineries  of  independent  firms. 

Various  devices  have  been  used  to  insure  secrecy, 
such  as  blind  billing,  false  billing,  failure  to  post  and  file 

1  Or  railroads  and  water  lines  when  the  two  modes  of  transport  are  operated 
“under  a  common  control,  management  or  arrangement,  for  a  continuous  carriage 
or  shipment.” 

2  Report  of  the  Commissioner  of  Corporations  on  the  Transportation  of 
Petroleum,  1906. 


DISCRIMINATION  AMONG  SHIPPERS  177 


rates,  naming  rates  for  goods  transported  in  one  kind  of 
car  while  carrying  the  same  goods  more  cheaply  in  an¬ 
other  kind  of  car,  etc.  The  lowest  published  rate  on 
oil  from  Pennsylvania  refining  points  into  Vermont  in 
1904,  was  23!  cents  per  hundred  pounds.  The  Standard 
Oil  Company,  however,  reached  these  points  from  its 
refinery  at  Olean,  N.  Y.,  by  way  of  Norwood,  N.  Y.,  for 
from  15.3  to  16.9  cents  per  hundred.1  The  combination 
of  rates  under  which  this  company’s  oil  was  shipped 
consisted  of,  first,  a  secret  rate  from  Olean  to  Rochester, 
over  a  part  of  the  Pennsylvania  lines,  a  rate  neither  filed 
nor  posted,  and  used  in  connection  with  blind  billing ; 2 
second,  a  rate  of  9  cents  per  hundred  pounds  over  the 
New  York  Central  road  from  Rochester  to  Norwood; 
third,  low  rates  over  the  Rutland  and  Central  Vermont 
railroads.  Copies  of  the  blind  waybills  of  the  Pennsyl¬ 
vania  Railroad  gave  evidence  that  a  large  number  of  cars 
ostensibly  billed  to  Rochester  were  really  destined  to 
places  in  Vermont.  There  was  apparently  a  pretense 
that  the  traffic  was  intrastate,  in  order  that  there  might 
be  an  excuse  for  the  failure  to  file  and  post  the  rates  in 
accordance  with  the  Federal  law  on  interstate  transpor¬ 
tation.  The  open  tariff  rate  of  the  Rutland  Railroad 
Company,  on  oil  in  barrels,  from  Norwood,  N.  Y.  to 
Burlington,  Rutland,  Bellows  Falls,  and  other  Vermont 
points,  was  33  cents  per  hundred  pounds.  But  it  ap¬ 
peared  that  the  Rutland  had,  to  these  three  points,  from 
Norwood,  in  connection  with  the  Central  Vermont  Rail¬ 
road,  very  low  tank  car  rates  of  $23,  $28,  and  $30,  re¬ 
spectively,  per  tank  car ;  and  it  appeared,  also,  that  for 


1  Ibid.,  pp.  92-112. 

2  That  is,  the  waybills  omitted,  in  each  case,  a  statement  of  the  rate  and  of  the 
total  amount  of  the  freight  charge. 

PART  m  —  N 


178  TRANSPORTATION  COSTS  OF  COMMERCE 


some  time  there  had  been  no  limit  on  the  size  of  tank 
cars  so  used.  Investigation  showed  that  the  tank  cars 
sent  to  the  above-mentioned  three  places  from  the  Penn¬ 
sylvania  system  were  large,  having  an  average  capacity 
of  60,000  pounds.  The  average  rate  per  hundred  pounds 
in  these  tank  cars  was,  therefore,  between  less  than  4  and 
5  cents,  instead  of  33  cents  as  in  barrel  shipments.  In¬ 
dependent  shippers  had  repeatedly  asked  for  rates  into 
Vermont,  but  had  never  received  information  of  these 
low  tank  car  rates. 

The  Standard  Oil  Company,  it  was  shown  in  the  same 
government  report,  got  entrance  to  southern  territory, 
from  its  great  refinery  at  Whiting,  Ind.,  largely  via 
Grand  Junction,  Tenn.  There  was  a  rate  filed  reading 
only  to  Grand  Junction.1  There  was  no  tariff  of  the 
Southern  Railway,  reading  from  Grand  Junction  to 
other  destinations,  filed  with  the  Interstate  Commerce 
Commission.  The  officers  of  the  Southern  Railway 
Company  claimed  that  they  believed  they  were  merely 
collecting  their  proportion  of  a  through  rate  published 
by  the  other  roads.  Whatever  the  facts  as  to  this  con¬ 
tention,  the  low  rate  was  not  practically  available  to 
other  shippers  than  the  Standard  Oil  Company. 

But  the  rate  based  on  Grand  Junction  was  effectively 
secret  for  another  reason.2  Though  the  13-cent  rate  as 
far  as  Grand  Junction  was  filed  with  the  Interstate 
Commerce  Commission,  yet  this  rate  was  not  made  to 
read  from  Whiting,  Ind.,  where  the  Standard’s  refinery 
was  located,  nor  from  Chicago,  Ill.,  just  across  the  state 
border,  but  from  insignificant  near-by  towns.  Thus, 


1  Report  of  the  Commissioner  of  Corporations  on  the  Transportation  of 
Petroleum,  1906,  p.  250. 

2  Ibid.,  pp.  268,  269. 


DISCRIMINATION  AMONG  SHIPPERS  179 


the  tariff  of  the  Illinois  Central  Railroad,  naming  the 
13-cent  rate,  read  from  Riverdale,  Ill.,  and  the  later  tariff 
of  the  Chicago  and  Eastern  Illinois,  from  Dolton,  Ill., 
both  of  these  places  being  obscure  junction  points  in  the 
Chicago  switching  district.  An  independent  shipper 
would  naturally  inquire  the  rate  from  Chicago  to  southern 
cities,  not  the  rate  from  Riverdale  or  from  Dolton,  and 
in  fact,  the  Chicago  and  Eastern  Illinois  Railroad  itself, 
when  the  Bureau  of  Corporations  (carrying  on  the  inves¬ 
tigation  preparatory  to  its  report)  asked  for  the  rates 
from  Whiting  to  numerous  points  in  the  South,  made 
no  reference  to  the  Grand  Junction  combination,  but  re¬ 
ported,  in  writing,  rates  based  on  Evansville.  Both  the 
Chicago  and  Eastern  Illinois  Railroad  and  the  Illinois 
Central  Railroad  practiced  blind  billing. 

Another  method  of  discriminating  without  seeming  to 
do  so  is  by  the  use  of  a  so-called  industrial  railroad.  A 
manufacturing  concern  has  constructed  about  its  plant 
a  few  thousand  feet  of  trackage.  The  ownership  and 
control  of  such  trackage  is  vested  in  a  “Railroad  Com¬ 
pany,”  which  in  turn  is  owned  by  the  manufacturing 
concern.  Then  the  diminutive  railroad  system  or  com¬ 
pany  is  allowed,  by  other  railroads,  a  share  of  the 
through  rate  to  destinations,  in  excess  of  the  real  value 
of  its  services.  In  the  ultimate  analysis,  the  manufac¬ 
turing  corporation  receives  the  real  benefit,  and,  in 
effect,  pays  lower  rates  for  transportation  than  do  its 
rivals. 

A  case  decided  by  the  Interstate  Commerce  Commis¬ 
sion  in  1904  supplies  an  illustration  1  of  discrimination 
so  brought  about.  It  was  shown,  in  this  case,  that  the 
International  Harvester  Company  owned  the  capital 

1  Interstate  Commerce  Reports,  Vol.  X,  pp.  385-404. 


i8o  TRANSPORTATION  COSTS  OF  COMMERCE 


stock  of  the  Illinois  Northern  Railroad,  and  a  controlling 
interest  in  the  Chicago,  West  Pullman  and  Southern 
Railroad  Company.  These  two  railroad  companies 
were  terminal  connecting  roads  operating  in  and  about 
the  city  of  Chicago  between  the  plant  of  the  Harvester 
Company  and  various  railroads  and  other  industries. 
Until  about  the  time  of  the  complaint  before  the  Com¬ 
mission,  these  terminal  roads  had  received,  for  their 
services,  switching  charges  of  from  $i  to  $3.50  per  car. 
But  this  allowance  had  been  increased,  until  it  came  to 
be  a  division  of  the  through  rate  to  destination,  amount¬ 
ing  sometimes  to  20  per  cent,  of  the  rate,  or  $12  per  car 
of  20,000  pounds,  instead  of  the  former  maximum  of 
$3.50.  These  high  charges  were  regarded  by  the  Com¬ 
mission  as  unlawful  discrimination  in  favor  of  the  In¬ 
ternational  Harvester  Company,  and  were,  therefore, 
forbidden. 

§  2 


Competition  of  Transportation  Lines  as  Causing  this 

Discrimination 

What  is  to  be  said  as  to  the  causes  of  discrimination 
among  shippers?  Competition  of  transportation  com¬ 
panies,  e.g.  railroads,  with  each  other,  the  fear  of  each 
that  it  will  lose  large  traffic  to  its  rivals,  is  generally  put 
forth  as  the  principal  explanation.  It  is  a  case  of  charg¬ 
ing  what  the  traffic  will  bear.  And  it  is  a  case  of  charg¬ 
ing  what  the  traffic  will  bear  without  being  diverted; 
not  what  it  will  bear  without  being  destroyed.  This 
seems  to  mean  special  concessions  where  there  is  special 
fear  of  large  diversion  of  traffic  to  rivals.  One  might 
suppose  that  competition  would  mean  lower  rates  to  all 
shippers  rather  than  to  a  favored  few  only  or  to  one. 


DISCRIMINATION  AMONG  SHIPPERS  181 


Two  reasons  may  be  suggested  to  account  for  the  fact 
that  reductions  are  made  to  some  shippers  and  not  to 
others.  In  the  first  place,  the  transportation  company 
making  the  special  rate  is  anxious  that  rivals  shall  not 
know  of  it  lest  these  rival  transportation  lines  get  the 
traffic  by  offering  as  low  or  lower  rates.  But  if  the 
reduction  is  general,  it  is  soon  known  to  rival  lines.  In 
the  second  place,  reductions  are  made  to  the  very  large 
shippers  through  fear  of  losing  their  traffic.  There  is 
much  less  fear  of  losing  the  business  of  small  shippers, 
because  this  business  is  looked  upon  as  relatively  un¬ 
important.  And  it  is  to  be  noted  that  what  the  large 
shipper  wants  and  is  likely  to  insist  upon,  if  he  feels  his 
power  sufficient,  is  not  merely  low  rates,  but  a  difference 
in  rates  between  him  and  his  competitors.  If  a  large 
shipper,  controlling  f  of  the  business  in  any  kind  of 
goods,  while  the  remaining  3-  is  produced  by  scattered 
independents,  threatens  a  railroad  company  with  entire 
loss  of  patronage  unless  the  railroad  company  will  dis¬ 
criminate  secretly  in  his  favor,  the  railroad  is  likely  to  be 
frightened  into  submission.  It  may  not  have  to  submit 
to  live,  but  its  officers  think  submission  will  bring  greater 
profits  than  refusal.  Hence  they  agree  to  special  rates 
which  the  scattered  independents  may  not  enjoy.  At 
one  time  (1885)  the  Standard  Oil  Company  paid  10 
cents  a  barrel  to  have  its  oil  carried  a  given  distance  on 
the  Cincinnati  and  Marietta  Railroad,  while  its  competi¬ 
tors  were  required  to  pay  35  cents.  As  if  this  were  not 
discrimination  enough,  the  excess  25  cents  charged  to 
its  rivals  was  to  be  turned  over  to  the  Standard  Oil 
Company.1 

1  Tarbell,  The  History  of  the  Standard  Oil  Company,  New  York  (McClure 
Phillips  and  Co.),  1904,  pp.  77-86. 


iS2  TRANSPORTATION  COSTS  OF  COMMERCE 

In  order  to  prevent  competition  from  taking  this  form, 
the  law  has  to  provide  and  enforce  severe  penalties,  just 
as  it  has  to  enforce  penalties  against  “competition” 
which  takes  the  form  of  killing  a  competitor,  or  destroy¬ 
ing  his  property,  or  misrepresenting  his  goods,  or  using 
child  labor.  Under  section  two  of  the  Interstate  Com¬ 
merce  Act,  discrimination  between  shippers  is  illegal 
by  whatever  special  rate,  rebate,  drawback,  or  other 
device  it  may  be  brought  about.  The  Interstate 
Commerce  Commission  has  authority  over  rate  prac¬ 
tices  and  can  investigate  cases  where  discrimination  is 
suspected.  Furthermore,  the  Elkins  law  of  1903,  as 
amended  in  1906,  makes  both  the  giving  and  the  re¬ 
ceiving  of  a  concession  from  the  published  rate  a 
criminal  offense. 

It  is  not  intended  to  assert  that  lower  rates  per  hun¬ 
dred  pounds  should  not  be  charged  on  large  shipments 
than  on  smaller  ones,  to  the  extent  that  the  larger  ship¬ 
ments  are  carried  at  proportionately  less  cost  by  virtue 
of  their  concentration.  That  the  rate  should  be  lower 
on  carload  than  on  less  than  carload  lots,  is  generally 
recognized.  There  may  be  equal  justification  for  a 
somewhat  lower  rate,  per  hundred  pounds,  on  trainload 
than  on  carload  lots,  provided  that  the  difference  is 
not  excessive  and  that  the  lower  large-scale  rates  are 
open  to  all  shippers  alike  on  equal  terms.  But  it  is 
hard  to  believe  that  any  saving  in  the  handling  of  large 
lots  is  sufficient  to  justify  such  discrimination  as  that 
above  mentioned,  where  one  company  paid  10  cents  for 
a  service  that  others  could  get  for  not  less  than  35 
cents,  and  had  its  10-cent  rate  reduced  by  getting  the 
surplus  25  cents  on  all  others’  shipments. 


DISCRIMINATION  AMONG  SHIPPERS  183 


§  3 

Other  Causes  of  Discrimination  among  Shippers 

Other  influences  than  competition  of  transportation 
lines  may  cause  discrimination  among  shippers.  With 
or  without  competition,  there  would  be  likely  to  result 
discrimination  in  favor  of  industrial  concerns  in  which 
some  of  the  principal  stockholders  or  some  of  the  direc¬ 
tors  or  important  officials  of  transportation  companies 
have  financial  interests.  That  the  principal  stock¬ 
holders  and  directors  in  some  big  industrial  concerns 
which  have  received  such  favors  are  also  largely  in¬ 
terested  in  railroads,  is  generally  recognized.  But  there 
appears  to  be  no  instance  of  discrimination  among  ship¬ 
pers  where  the  discrimination  has  been  definitely  traced 
to  this  cause. 

A  special  report 1  of  the  Interstate  Commerce  Com¬ 
mission  in  1907,  however,  presented  evidence  showing 
that  the  Pennsylvania  Railroad  system  had  discriminated 
in  its  allotment  of  cars  in  favor  of  coal  companies  in 
which  some  of  its  officials  were  interested.  These  offi¬ 
cials  had  in  some  cases  bought  their  stock  in  coal  com¬ 
panies,  had  in  other  cases  obtained  it  mainly  by  promot¬ 
ing  or  allowing  their  names  to  be  used  in  promoting  said 
companies,  and  had  in  still  other  instances  been  given 
the  stock  outright  by  promoters.2  It  appeared  that 
during  a  period  of  six  weeks  in  the  early  part  of  1903, 
when  coal  was  in  great  demand,  a  large  number  of  mines 
on  the  Pennsylvania  system  were  left  without  any  car 
supply  whatever.  So  far  as  could  be  learned,  however, 

1  Discrimination  and  Monopolies  in  Coal  and  Oil,  Special  Report  by  the 
Interstate  Commerce  Commission,  1907. 

2  Ibid.,  p.  23. 


184  TRANSPORTATION  COSTS  OF  COMMERCE 


no  mine  on  the  Pennsylvania  system,  in  which  an  officer 
of  that  company  was  interested  as  a  security  holder, 
was  left,  during  the  period  in  question,  without  car 
service.1 

Discrimination  in  fact,  if  not  in  form,  is  likely  to  result 
when  a  transportation  line,  as  a  corporation,  owns  a 
producing  company  or  the  securities  of  a  producing 
company.  Under  such  circumstances  may  come  the 
temptation  to  the  transportation  line  to  make  rates 
which  will  drive  out  independent  producing  concerns. 
It  is  to  be  noted  that  discrimination  so  caused  can  be  at 
its  worst  when  there  is  monopoly  of  transportation. 
When  competition  exists,  the  independent  producing 
firm,  if  denied  reasonable  rates  by  one  line,  has  at  least 
a  recourse  to  that  line’s  competitors  and  may  ship  by 
the  line  offering  the  lowest  rates.  When  there  is  trans¬ 
portation  monopoly,  high  rates  to  independent  produc¬ 
ing  firms  may  drive  these  firms  out  of  business,  estab¬ 
lishing  in  complete  control  the  subsidiary  corporations 
through  which  the  transportation  line  (or  lines)  carries 
on  industrial  ventures.  It  is  not  even  essential  that  the 
rates  should  be  nominally  higher  for  the  independent 
firms  than  for  those  producing  corporations  which  the 
transportation  company  owns.  It  matters  not  how  high 
rates  are  made  for  a  subsidiary  company  owned  by  a 
transportation  line.  Whatever  such  a  dependent  com¬ 
pany  loses  in  having  to  pay  higher  freight  rates,  the 
transportation  line  which  owns  it  gains.  It  matters 
not  how  much  a  company  pays  for  any  service,  when  it 
only  pays  itself.  But  it  does  matter  to  independent 
companies  how  high  rates  they  must  pay.  High  rates 

1  Discrimination  and  Monopolies  in  Coal  and  Oil,  Special  Report  by  the 
Interstate  Commerce  Commission,  1907,  p.  63. 


DISCRIMINATION  AMONG  SHIPPERS  185 


to  them  mean  loss  of  profits  and  mean  ultimate  bank¬ 
ruptcy.  Discrimination  caused  in  this  way  is  asserted, 
in  government  reports,1  to  have  been  practiced  by  the 
railroads  serving  the  anthracite  coal  mines  in  and  near 
Pennsylvania.  The  effect  seems  to  have  been  to  force 
out  independent  mining  concerns  and  to  enable  the  rail¬ 
roads  to  get  possession  of  many  anthracite  coal  mines.2 

§  4 

The  Practice  of  Discriminating  among  Shippers ,  Tested 

hy  the  Principles  of  Industrial  and  Commercial  Ethics 

It  has  already  been  suggested  that  somewhat  lower 
rates  for  large  shipments  than  for  small  ones  may  often 
be  defensible  if  open  to  all  alike.  So  far  as  there  is  a  real 
saving  to  a  transportation  company,  in  taking  for  ship¬ 
ment  a  large  quantity  of  any  goods  at  a  time,  it  is  proper 
that  rates  should  be  so  adjusted  as  to  encourage 
large  shipments.  But  arbitrary  discrimination  among 
shippers,  i.e.  favoritism,  by  transportation  lines  has 
nothing  whatever  to  commend  it.  It  tends  to  build  up 
private  monopolies.  It  injures  consumers.  It  violates 
the  principles  of  industrial  and  commercial  ethics. 

That  discrimination  among  shippers  tends  to  build 
up  monopolies  and  to  force  out  would-be  competitors 

1  2d  Session,  52d  Congress,  H.  R.  2278,  pp.  iii,  iv,  and  vi;  also  Industrial 
Commission  Reports,  1902,  Vol.  XIX,  p.  462. 

2  The  “Commodity  Clause”  of  the  Hepburn  Act  of  1906,  which  was  intended 
to  make  impossible  this  ownership  by  railroads,  of  producing  companies  or  of 
goods  transported  (with  the  exception  of  timber  and  its  manufactured  products), 
has  been  so  interpreted  by  the  Supreme  Court  as  to  make  it  of  doubtful  impor¬ 
tance.  See  United  States  v.  Delaware  and  Hudson  Company,  213  U.  S.,  366; 
United  States  v.  Lehigh  Valley  Ry.,  220  U.  S.,  257;  United  States  v.  Erie  Ry., 
220  U.  S.,  275 ;  U nited  States  v.  Delaware,  Lackawanna  and  Western  Railroad  Co. 
and  the  Delaware,  Lackawanna  and  Western  Coal  Co.,  35  Supreme  Court  Reporter, 
873. 


186  TRANSPORTATION  COSTS  OF  COMMERCE 


is  too  obvious  to  require  much  further  proof.  The  com¬ 
pany  which  has  to  pay  a  higher  freight  rate  is  disad¬ 
vantaged  to  that  extent  in  the  struggle  to  make  a  low 
price  to  the  consumer  while  yet  disposing  of  its  goods  at 
a  profit. 

The  railroads  (or  navigation  companies),  taken  as  a 
whole,  have  nothing  to  gain  by  favoritism.  They  do 
not  have  greater  traffic  in  any  commodity,  e.g.  they  do 
not  have  greater  traffic  in  oil,  merely  because  by  favorit¬ 
ism  they  have  enlarged  one  shipper’s  business,  while 
simultaneously  ruining  other  shippers.  Thus,  the  rail¬ 
road  plants  are  not,  taken  as  a  whole,  more  fully  utilized 
by  such  discrimination.  Indeed,  to  the  extent  that  the 
railroads  build  up  a  monopoly  which,  by  making  high 
prices,  curtails  consumption,  they  may  lose  traffic. 
Effectively  to  prohibit  this  form  of  competition  among 
transportation  companies  would  leave  these  transpor¬ 
tation  companies  no  worse  off  and  perhaps  better  off. 
The  condition  is  somewhat  parallel  to  that  which  con¬ 
fronts  us  when  we  attempt  to  prohibit  child  labor  or 
to  limit  the  hours  of  adult  labor  in  mines,  etc.  Each 
company  concerned  may  be  not  unwilling  to  conform, 
provided  it  can  have  assurance  that  its  competitors  will 
do  likewise.  Such  cases  come  under  one  of  the  classes 
of  cases,  which,  John  Stuart  Mill  believed,  justified 
interference  of  government  in  economic  affairs,  viz., 
where  something  is  to  the  general  interest,  but  where 
nobody  concerned  is  likely  to  conform  to  this  interest 
voluntarily.1  The  force  of  law  may  then  properly  com¬ 
pel  conformity  on  the  part  of  all. 

Discrimination  among  shippers  can  hardly  be  said  to 
benefit  consumers.  If  it  takes  the  form  of  abnormally 

1  Mill,  Principles  of  Political  Bconomy ,  Book  V,  Chapter  XI,  Section  12. 


DISCRIMINATION  AMONG  SHIPPERS  187 


high  rates  charged  the  competitors  of  the  favored  com¬ 
pany,  consumers  are  simply  deprived  of  the  benefit  of 
competition  by  these  other  concerns,  without  getting  the 
goods  from  the  favored  firm  at  any  lower  prices.  The 
resulting  monopoly  will  almost  certainly  bring  higher 
prices.  Even  if  the  discrimination  takes  the  form  of 
abnormally  low  rates  to  the  favored  corporation,  con¬ 
sumers  will  hardly  derive  permanent  benefit  from  it. 
The  favored  corporation  can  appropriate  the  difference 
between  its  freight  rate  and  that  of  its  rivals,  or  it  can 
drive  them  out  of  business  and  thereafter  appropriate 
more  than  the  difference.  A  low  rate,  which  is  in  the 
nature  of  a  special  privilege,  is  not  likely  to  inure  to  the 
benefit  of  the  general  public. 

Personal  discrimination  not  only  does  not  benefit,  and 
tends  to  injure  railroads  and  consumers ;  it  also  fails  to 
stimulate  the  productive  power  of  the  community  and 
tends  rather  to  weaken  it.  It  removes,  to  a  degree,  the 
greatest  stimulus  of  efficiency,  viz.,  the  consciousness 
that  by  efficiency  and  by  it  alone,  can  success  be  attained. 
There  is  no  certainty  that  the  most  efficient  company 
will  be  the  one  most  favored  by  discrimination.  Favors 
are  more  likely  to  go  to  a  large  concern  than  to  a  pro¬ 
gressive  and  growing  one.  And  even  if,  as  doubtless 
not  infrequently  happens,  the  favored  concern  is  also, 
at  the  time,  the  most  efficient,  a  knowledge  that  dis¬ 
criminating  rates  will  partly  protect  it  from  competition 
certainly  is  not  conducive  to  keeping  it  thus  efficient. 
In  short,  survival  in  competition,  through  favoritism,  is 
likely  not  to  be  a  survival  of  the  socially  fittest. 

When  men  are  organized  in  a  community  or  nation, 
the  survival  of  this  community  or  nation  is  of  funda¬ 
mental  importance.  The  struggle  for  existence  has 


i88  TRANSPORTATION  COSTS  OF  COMMERCE 


provided  sufficient  evidence  that  men  who  are  isolated 
are  at  a  disadvantage ;  organized  society  helps  the  in¬ 
dividuals  in  it  to  life  and  happiness.  Therefore,  with 
men,  the  struggle  for  existence  has  long  since  taken  the 
form  of  a  struggle  or  competition  between  groups.1 
The  group  which,  all  other  things  equal,  has  the  best 
organization  and  the  highest  types  of  men,2  is  most  likely 
to  prevail.  Those  characteristics,  those  standards  of 
right,  and  those  organizations  within  a  community 
which  are  most  calculated  to  further  the  welfare  of  the 
whole  and  its  continued  survival,  must  be  adjudged  the 
fittest.  For  this  reason,  the  competitive  system  of  in¬ 
dustry  has  been,  by  most  writers,  regarded  as  desirable. 
It  stimulates  efficiency  among  the  members  of  a  group 
and,  therefore,  in  the  group  as  a  whole.  For  this  reason, 
the  aim  of  eugenics  is  sound.  Its  purpose  is  to  stop  the 
breeding  of  poor  units  of  society  and  bring  about  a  breed- 
ing,  more  largely,  from  the  strong,  the  alert,  the  success¬ 
ful.  For  this  reason,  monopoly  established  by  the 
favoritism  of  transportation  companies  is  undesirable. 
Consumers  are  likely  to  suffer  in  the  end.  Efficiency 
is  likely  to  be  less.  The  community  as  a  whole  is  injured 
and  therefore  weakened.  There  is  a  great  difference  in 
the  effect  on  the  general  welfare  between  monopoly 
which  is  gained  and  kept  by  efficiency  alone,  and  mo¬ 
nopoly  which  is  the  result  of  artificial  advantages,  mak¬ 
ing  competition  by  others  difficult  or  impossible. 


1  Cf .  on  this  topic  in  its  connection  with  economic  activities,  Hadley,  Econom¬ 
ics,  New  York  (Putnam),  1906,  pp.  18-23. 

2  At  least,  as  regards  their  relations  to  fellow  members  of  their  own  group. 
Whether  considerate  dealing  with  members  of  alien  groups  is  any  advantage  may 
depend  largely  on  the  stage  of  development  of,  and  the  strength  of,  world  opinion. 
Such  dealing  may  conceivably  make,  for  a  national  group,  all  the  difference  be¬ 
tween  living  in  a  world  of  friends  or  a  world  of  united  enemies. 


DISCRIMINATION  AMONG  SHIPPERS  189 


There  is  a  considerable  analogy  between  transporta¬ 
tion  discrimination  and  the  protective  tariff  system.  In 
both  cases,  some  producers  (by  the  protective  tariff, 
foreign  producers)  are  put  at  an  arbitrary  disadvantage 
compared  with  others.  In  both  cases  the  rule  that  suc¬ 
cess  should  depend  on  efficiency  in  service  is  violated. 
In  both  cases,  competition  is  seriously  restricted  and 
monopoly  may  result.1  In  one  case,  efforts  of  persons 
desiring  the  favoritism  are  turned  from  the  search  for 
more  efficient  methods  of  production  into  selfish  po¬ 
litical  activity ;  in  the  other  case,  efforts  which  might  be 
devoted  to  rivalry  in  efficiency  are  turned  to  the  persua¬ 
sion  or  browbeating  of  transportation  lines’  managers. 
In  both  cases,  the  public  is  likely  to  suffer. 

The  ideal  of  industrial  and  commercial  organization 
requires  that  there  should  be  ever  active  in  business  a 
rivalry  of  business  men  and  corporations  in  serving  well 
the  community,  and  that  success  should  come  to  those 
whose  service  is  the  best.  An  individualistic,  as  distin¬ 
guished  from  a  socialistic  or  a  communistic  society,  relies 
frankly,  to  a  great  degree,  on  the  self-interest  of  men 
and  their  interest  in  their  own  immediate  families,  as 
motives  to  economic  activity.  To  the  extent  that  an 
individualistic  society  realizes  its  own  proper  ideal,  it 
endeavors  by  public  opinion  and  by  definite  and  enforced 
law  to  prevent,  absolutely,  all  anti-social  means  of  gain, 
to  prevent  all  methods  of  carrying  on  business,  which 
are  antagonistic  to  the  ultimate  well-being  of  the  social 
group.  So  far  as  it  is  possible  to  do  this,  the  only  profit¬ 
able  lines  of  activity  left  open  are  those  in  which  the 
individual  gains  the  most  for  himself  by  doing  the  most 
for  the  community.  He  who  invents  labor-saving  ma* 

1  Cf.  Part  II,  Chapter  VI,  §  io. 


190  TRANSPORTATION  COSTS  OF  COMMERCE 

chinery,  he  who  best  organizes  the  forces  of  production, 
he  who  best  economizes  raw  materials,  he  who  accumu¬ 
lates  needed  capital,  he  who  is  therefore  able  to  offer 
the  public  the  most  for  a  given  money  return,  finds  him¬ 
self  most  prosperous.  The  attainment  of  such  an  ideal 
of  industrial  and  commercial  life,  as  is  here  suggested, 
would  not  preclude  the  possibility  of  an  individual’s 
acquiring  great  wealth.  Under  the  reign  of  this  ideal, 
great  wealth  would  become,  except  where  acquired  by 
gift  or  inheritance,  an  evidence  of  great  service,  and, 
therefore,  a  valid  title  to  distinction.  It  would  not  be, 
as  is  now  too  often  the  case,  a  badge  of  dishonor.  It  is 
conformity  to  this  ideal  of  industrial  and  commercial 
life,  by  the  individual  and  the  group,  which  constitutes 
industrial  and  commercial  morality. 

To  hasten  the  more  complete  realization  of  such  an 
industrial  ideal,  we  must  express  ourselves  in  its  favor 
and  denounce  its  opposite.  When  we  do  this,  however, 
we  are  liable  to  be  told  that  those  who  have  succeeded 
in  accumulating  wealth  by  anti-social  means,  for  example, 
by  illegal  and  discriminatory  railroad  rates,  are  no 
worse  than  many  others  who  have  remained  poor ;  that 
many  competitors  would  gladly  have  done  likewise  if 
they  could,  but  simply  lacked  the  chance  or  the  sharp¬ 
ness  ,  that  it  is  not  right,  is  cruel,  in  short,  continually 
to  denounce  the  men  who  have  succeeded. 

Those  who  take,  without  qualification,  this  attitude, 
miss  the  whole  social  philosophy  of  disapproval  and 
punishment.  Every  wrongdoer,  be  he  murderer,  thief, 
or  industrial  free-booter,  is  the  product  of  two  forces, 
heredity  and  environment.  He  is  made,  absolutely,  by 
these.  Why,  therefore,  some  may  ask,  make  him  suffer 
for  wrongdoing,  by  disapproval  or  punishment.  The 


DISCRIMINATION  AMONG  SHIPPERS 


191 

answer  is  threefold.  First,  restraint  is  necessary  on  the 
criminally  disposed,  in  order  to  protect  society  against 
their  anti-social  activities.  Second,  society’s  disapproval 
and  punishment,  or  the  fear  of  these,  are  themselves 
part  of  the  environment  which  molds  men,  and  are, 
therefore,  in  some  degree,  preventive  of  wrong.  Third, 
denunciation  of  wrongdoing  arouses  the  unnoting  and 
the  indifferent,  and  so  helps  to  establish  and  enforce 
prohibitions.  If  we  would  have  a  true  industrial  and 
commercial  morality  generally  practiced,  we  must  mani¬ 
fest  open  disapproval  of  industrial  free-booting.  Thus 
only  can  we  be  confident  of  developing,  in  the  rising 
generation,  a  sentiment  against  industrial  and  com¬ 
mercial  immorality,  of  arousing  society  to  active  oppo¬ 
sition,  and  of  making  unfair  methods  of  wealth-getting 
no  longer  pay.  We  must  have  such  laws  and  such 
enforcement  of  laws  that  it  will  only  be  worth  while  to 
accumulate  wealth  by  service. 

§  5 

Summary 

Discrimination  among  shippers  is,  we  have  seen, 
practiced  in  evasive  ways,  partly  because  of  its  illegality 
and  of  popular  disapproval.  These  ways  include  blind 
billing,  false  billing,  use  of  special  equipment,  such  as 
tank  cars  by  favored  shippers  at  secret  rates,  making 
discriminating  rates  read  from  insignificant  points  so 
that  others  than  the  favored  companies  shall  not  know 
of  them,  allowing  large  sums  for  the  services  of  terminal 
railroads  or  sidings  owned  by  corporations,  and  various 
other  concealments  and  evasions.  Discrimination  is 
caused  by  competition,  by  interest  of  stockholders,  di- 


j92  TRANSPORTATION  COSTS  OF  COMMERCE 


rectors,  or  officers  of  a  transportation  company  in  other 
companies,  and  by  interest  of  a  transportation  com¬ 
pany  itself  in  other  companies.  Discrimination  among 
shippers  does  not  benefit  transportation  companies 
themselves,  taken  as  a  whole,  nor  does  it  bring  economy 
by  more  fully  utilizing  the  transportation  plants.  It 
tends  to  injure  consumers.  It  builds  up  monopoly. 
It  conduces  to  the  survival  of  the  relatively  inefficient. 
It  violates  the  proper  ideal  of  industrial  and  commercial 
morality.  It  deserves,  in  full,  the  condemnation  it 
generally  receives,  and  should  be  persistently  hunted 
down  and  rooted  out  of  our  business  life. 


INDEX 


A 

Acceptance  bills,  form  of  documentary- 
commercial  drafts  called,  I.  6g. 

Accounting,  system  of,  prescribed  for 
transportation  companies  by  Inter¬ 
state  Commerce  Commission,  III. 
io  n. 

Advertising  value  of  a  nation’s  ship¬ 
ping,  II.  159-160. 

Agreements,  between  railroad  com¬ 
panies,  for  maintenance  of  rates,  III. 
71-72;  made  illegal,  72-73;  argu¬ 
ments  for,  when  properly  supervised, 
74-75,  103 ;  between  navigation 

companies,  75-81 ;  governmental 
regulation  of,  81-83. 

Agriculture,  results  of  a  policy  of 
protection  to,  II.  72-73 ;  fallacious 
home  market  argument  for  pro¬ 
tection  addressed  to  those  concerned 
in,  1 24-1 27;  the  argument  for 
protection  to,  in  the  older  countries, 
against  a  doubtful  future,  1 27-1 29. 

Alabama  Midland  Case,  III.  108-110. 

Anti-trust  Law  of  1890,  monopoly 
rates  prevented  by,  III.  72,  73 ;  ap¬ 
plication  of,  to  combinations  and 
agreements  of  navigation  companies, 
81. 

Arbitraging  in  exchange,  I.  96-97. 

B 

Ballast  cargo,  low  rate  of  transporta¬ 
tion  for,  III.  162. 

Bank  acceptances,  system  of,  used  in 
Europe,  I.  37-39,  69. 

Bank  credit,  nature  of,  I.  26  ff. ;  rela¬ 
tion  of  money,  together  with,  to 
prices,  43-45  ;  fluctuations  of,  due 
to  periods  of  hope  and  confidence 
and  of  doubt  and  fear,  46 ;  changes 
in,  resulting  from  panics,  46-47 ; 
means  provided  for  avoiding  violent 
fluctuations  of,  47-49. 

o 


Bank  deposits,  I.  28. 

Bank  drafts,  use  of,  I.  52  ;  both  drawers 
and  drawees  of,  are  banks,  54 ; 
settlement  of  obligations  by,  when 
debtors  remit  to  creditors,  61  ff . ; 
different  types  of,  67-70.  See  Long 
drafts  and  Sight  drafts. 

Banking,  commercial,  I.  28-30 ;  analy¬ 
sis  of  the  relations  to  each  other 
of  persons  concerned  in,  30-33 ; 
advantages  possessed  by,  for  busi¬ 
ness  men,  both  as  lenders  and  bor¬ 
rowers,  33-40. 

Bank  notes,  are  credit  obligations  of 
banks  to  holders  of,  I.  41 ;  pro¬ 
tection  of  holders  against  loss, 

41- 43 ;  provisions  of  Federal  Re¬ 
serve  Act  relative  to,  42-43. 

Bank  of  England,  emergency  reserve 
of,  I.  47 ;  attitude  toward  exporta¬ 
tion  of  gold  during  European  war, 
iSO- 

Bank  reserves,  I.  42,  44;  method  of 
maintaining  proper  relation  between 
deposits  and,  44-45. 

Banks,  function  of,  to  act  as  inter¬ 
mediaries  between  borrowers  and 
lenders,  I.  30-33;  Federal  reserve, 

42- 43. 

Barter,  primitive  trade  called,  I.  1. 

Basing- point  system,  uneconomy  of 
the,  III.  108-111. 

Bastable,  The  Theory  of  International 
Trade,  cited,  I.  92,  113,  141,  143,  II. 
25,  30,  50,  54,  74,  81,  107,  132. 

Bauer,  article  on  “Returns  on  Public 
Service  Properties,”  cited,  III.  173. 

Beet  sugar  industry,  bounty  granted, 
in  Europe,  II.  144;  effects  of  boun¬ 
ties  on  bounty-paying  countries  and 
on  sugar-consuming  countries,  151- 
152. 

Bills  of  exchange,  I.  26,  27,  51-53; 
advantages  of,  over  checks  for  long¬ 
distance  transactions,  52-53 ;  nature 
of,  53-54  5  relations  of  bank  to  other 


193 


194 


INDEX 


parties  concerned  in,  53-54 ;  illus¬ 
tration  of  use  of,  to  settle  obliga¬ 
tions,  assuming  no  banks,  54-56; 
settlement  of  obligations  by,  through 
intermediation  of  banks,  assuming 
creditors  to  draw  drafts  on  debtors, 
56-61 ;  settlement  by  bank  drafts, 
when  debtors  remit  to  creditors, 
61-65 ;  variety  of  types  of,  67-70 ; 
sight  drafts  and  long  bills,  67 ; 
“clean”  bills  and  documentary, 
67-69 ;  discount  of,  69-70 ;  sale  of 
demand  drafts  against  remittances 
of  long  bills,  71—73 ;  method  of 
drawing  of,  by  letters  of  credit, 
94-96;  speculation  in,  96-100; 
relation  between  price  of  long  drafts 
and  rate  of  interest  or  discount, 
126-127;  holding  of  long  drafts  on 
foreign  countries  by  American  banks, 
as  investments,  1 27-130;  influence 
on  price  of  long  drafts  of  interest 
rate  in  drawing  country  and  interest 
rate  in  country  drawn  upon,  13 1- 
133;  effect  of  bank  discount  rate 
on  price  of  demand  drafts  and  the 
flow  of  specie,  133-136;  fluctuations 
in  price  of,  in  case  of  prohibition 
of  specie  shipment,  147-152. 

Bimetallism,  operation  of  theory  of, 
I.  16-18. 

Blind  billing,  discrimination  by  means 
of,  III.  176,  177-179. 

Borrowers,  relation  between  lenders 
and,  in  commercial  banking,  I. 
30-33;  benefits  to,  from  banking 
system,  35~37* 

Bounties,  nature  and  effects  of,  II. 
144  ff. ;  as  compared  and  contrasted 
with  protection,  144-145  ;  effect  of, 
on  level  of  money  prices  in  bounty¬ 
paying  countries,  146-148;  conse¬ 
quences  of,  to  general  welfare  of 
bounty-paying  country  and  of 
countries  with  which  it  trades, 
*48-152;  effects  on  wages  and 
rent,  152-153;  less  objectionable 
than  protection  for  encouraging 
infant  industries,  153 ;  comparison 
of  shipping  subsidies  and,  157-158. 

Brown,  H.  G.,  articles  by,  cited,  III. 
68,  170  n. 

Bulk  of  freight,  an  element  for  consid¬ 
eration  in  Iking  of  rates,  III.  161. 


C 

Canada,  protection  of  holders  of 
bank  notes,  under  banking  system 
of,  I.  41. 

Canals,  the  free  use  of  government- 
built,  II.  163,  165-172;  comparison 
of  railroads  and,  as  to  economy, 
1 70-1 71;  burden  of  building,  borne 
by  taxpayers,  171-172;  compara¬ 
tive  importance  of  general  expenses 
and  fixed  charges  on  railroads, 
natural  waterways,  and,  III.  29-31. 
Carload  shipments,  discrimination  in 
rates  on,  III.  no— in;  rates  may 
properly  be  lower  on,  than  on  small 
lots,  182. 

Carver,  views  of,  on  protection,  II. 
108  n. ;  The  Distribution  of  Wealth, 
cited,  III.  13  n.,  68. 

Checks  on  banks,  common  form  of 
credit,  I.  26,  27;  similarity  of  bills 
of  exchange  to,  52;  advantages  of 
bills  of  exchange  over,  in  long¬ 
distance  transactions,  52-53. 

Clare,  The  A.B.C.  of  the  Foreign  Ex¬ 
changes,  cited,  I.  63,  83,  93,  97,  140. 
Clayton  Act,  effect  of,  on  devices  for 
checking  competition,  III.  72. 
“Clean”  bills,  defined,  I.  67. 

Clearing  houses,  I.  29,  30. 

Coal,  protective  tax  on,  at  expense  of 
wage-earning  public,  II.  99. 

Coal  companies,  discrimination  by 
transportation  lines  in  favor  of 
certain,  III.  183-185. 

Coasting  trade,  United  States  laws 
concerning,  II.  155 ;  plan  of  grant¬ 
ing  free  use  of  Panama  Canal  to 
American,  165-169. 

Commercial  drafts,  use  of,  I.  52  ff. ; 
character  of  drawers  and  drawees  of, 
53-S4J  method  of  using,  for  settle¬ 
ment  of  obligations,  54  ff. 

Commercial  ethics,  ideals  of,  violated 
by  discrimination  among  shippers, 
III.  185-191. 

Commodity  Clause  of  Hepburn  Act 
of  1906,  III.  185  n. 

Competition,  effect  of,  on  prices,  I. 
6-8 ;  monopolies  secured  against 
foreign,  by  protective  tariff,  II.  113; 
of  transportation  companies,  III. 
37  ff*;  of  different  companies  over 


INDEX 


195 


the  same  route,  37;  of  routes,  37- 
40 ;  desirability  of  stimulus  of,  48 ; 
of  directions,  50-61 ;  of  locations, 
61-64 ;  against  potential  local  self- 
sufficiency,  64-65 ;  difference  be¬ 
tween  monopoly  rates  and  competi¬ 
tive  rates,  66-68 ;  devices  for  check¬ 
ing,  and  laws  against,  71-73  ;  reasons 
why  not  necessarily  ruinous,  73 ; 
devices  for  preventing,  in  water 
transportation,  75-86;  a  cause  of 
discrimination  in  rates,  among  places, 
94-96 ;  discrimination  among  places, 
due  to  competition  of  a  railroad  with 
a  water  line,  13  2-1 43  ;  illegitimate, 
sometimes  practiced  by  railroads 
against  water  lines,  143  ;  discrimina¬ 
tion  among  shippers  caused  by,  180- 
182. 

Conference  lines,  agreements  among, 
to  secure  monopoly  in  water  trans¬ 
portation,  III.  77-83. 

Constitutional  justification  of  a  pro¬ 
tective  tariff,  II.  1 1 2-1 13. 

Construction  costs,  influence  of,  on 
railroad  rates,  III.  20-22. 

Cost  of  carrying,  an  element  in  fixing 
of  rates,  III.  161. 

Cotton-raising  states,  disadvantages 
of  protective  tariff  to,  II.  112. 

Credit,  substitution  of,  for  money,  I. 
26-27. 

Crops,  relation  between  rate  of  ex¬ 
change  and,  I.  82-83. 

Currencies,  effect  of  difference  in,  on 
exchange  between  two  countries, 
I.  138-142. 

Currency,  use  of  term,  I.  26. 

Currency  loans,  I.  85,  86. 

Customer’s  check,  use  of,  for  money, 
I.  27. 

D 

Davenport,  H.  J.,  cited,  III.  13 1  n. 

Day,  A  History  of  Commerce,  cited,  II. 
70. 

Decreasing  cost,  extent  of  application 
of  law  of,  to  railroad  business,  III. 

13-14- 

Deferred  rebate  system,  a  device  for 
checking  competition  in  water  trans¬ 
portation,  III.  78-79. 

Demand  drafts,  sale  of,  against  remit¬ 


tances  of  long  bills,  I.  71-73.  See 
Sight  drafts. 

Diminishing  utility,  law  of,  II.  28. 

Directions,  competition  of,  III.  50  ff. ; 
competition  of,  involving  ocean 
carriers,  59-60;  discrimination  be¬ 
tween,  sometimes  economically  de¬ 
sirable,  153-156. 

Discount,  effect  of,  on  price  of  long 
drafts,  I.  126-127;  effect  of  bank 
discount  rate  on  price  of  demand 
drafts  and  the  flow  of  specie,  133- 
136;  effect  of  panics  on  rate  of, 
137-138- 

Discounting  of  documentary  payment 
bills,  I.  69-70. 

Discount  market,  absence  of  a,  in 
United  States,  I.  72-73. 

Discrimination,  competition  as  a 
cause  of,  among  places,  III.  94-96 ; 
economic  loss  which  may  flow 
from,  among  places,  97-103 ;  un¬ 
economy  of,  either  in  favor  of  or 
against  imports,  103-108;  un¬ 
economy  of  the  basing-point  system, 
108-111 ;  in  favor  of  intrastate  busi¬ 
ness,  resulting  from  orders  of  state 
commissions,  112-115;  by  a  trans¬ 
portation  company  in  favor  of  traffic 
moving  a  long  distance  over  its 
own  lines,  115-117;  cases  where 
economically  defensible,  among 
places,  120  ff . ;  by  the  longer  or 
longest  line,  when  there  is  competi¬ 
tion  of  directions  or  of  locations,  127- 
13 1 ;  by  the  shorter  or  shortest  line, 
when  such  a  line  has  comparatively 
light  traffic,  130-132  ;  among  places, 
by  a  railroad  competing  with  a 
water  line,  132-143;  among  places, 
by  a  railroad  competing  with  local 
self-sufficiency,  144-145  ;  in  favor  of 
export  traffic,  145-153;  between 
two  opposite  directions,  153-156; 
question  as  to  whether  economically 
desirable,  among  different  kinds 
of  goods,  160-173;  among  shippers, 
175  ff. ;  methods  of  practicing  and 
of  concealing,  among  shippers,  175- 
180;  caused  by  competition  of 
transportation  lines,  180-182;  penal¬ 
ized  by  Elkins  Law,  182 ;  various 
causes  of,  among  shippers,  183-185  ; 
practice  of,  among  shippers,  tested 


196 


INDEX 


by  principles  of  industrial  and  com¬ 
mercial  ethics,  185-191 ;  analogy 
between  protective  tariff  and,  189. 

Diversification-of-industries  argument 
for  protection,  II.  1 34-1 35. 

Documentary  commercial  drafts,  I. 
67,  68-69. 

Domestic  exchange,  cost  of  money 
shipment  in,  I.  115-116. 

E 

Edgeworth,  “  Report  on  Monetary 
Standard,”  cited,  I.  3  ;  “The  Theory 
of  International  Values,”  cited,  II. 
21 ;  discussion  of  view  of,  regarding 
effect  of  import  duty,  48  n. ;  dis¬ 
cussion  of  view  of,  as  to  possible 
effect  of  protection  in  increasing 
national  wealth,  107  n.-io8  n. 

Efficiency,  effect  on,  of  discrimination 
among  shippers,  III.  187. 

Efficiency  in  operation  of  railroads, 
premium  to  be  placed  on,  III.  90-91. 

Elkins  Law,  effect  of,  on  competition, 
III.  75 ;  provisions  of,  concerning 
discrimination  among  shippers,  182. 

Employment,  the  argument  that  pro¬ 
tection  makes,  II.  12  2-1 24. 

England,  exchange  transactions  be¬ 
tween  America  and,  I.  62-65;  dis¬ 
counting  in,  of  bills  drawn  by  Amer¬ 
icans  on  their  English  debtors,  71- 
72 ;  effect  of  European  war  on  rate 
of  exchange  on,  149-150;  wages 
and  prices  in  Germany  and,  com¬ 
pared,  II.  96;  error  made  in  com¬ 
paring  conditions  as  to  wages  in 
United  States  and,  120-122;  weak¬ 
ness  of  national  self-sufficiency  argu¬ 
ment  for  protection  shown  by  case 
of,  136-137 ;  gain  to,  from  export 
bounties  paid  on  beet  sugar  by  other 
countries,  151-152;  early  navigation 
acts  of,  155.  See  also  Great  Britain. 

Equation  of  exchange  of  money,  I. 
3-4,  24 ;  statement  of,  including 
bank  credit,  43. 

Erie  Canal,  the  free  use  of,  an  injus¬ 
tice  to  taxpayers  of  New  York  State, 
II.  169-170. 

Escher,  Elements  of  Foreign  Exchange, 
cited,  I.  65,  67,  69,  70,  71,  85,  90, 
93,  94,  96,  97,  99,  109,  hi. 


Ethics  of  the  question  of  protection 
or  free  trade,  II.  139. 

European  war,  and  the  exchange 
market,  I.  107,  149-150;  effect  of, 
on  flow  of  specie  abroad,  136  n. 

Exchange,  foreign  and  domestic,  I. 
S2-53;  par  of,  77-78,  139;  place 
speculation  or  arbitraging  in,  96-97 ; 
time  speculation  in,  97-100;  be¬ 
tween  two  countries  when  one  has 
a  gold  and  the  other  a  silver  stand¬ 
ard,  138-142.  See  Bills  of  exchange 
and  Rate  of  exchange. 

Exchangeability  of  money,  I.  2. 

Exchange  banks  and  brokers,  I.  53,  56 ; 
how  profits  are  made  by,  65-67. 

Exchange  market,  the,  I.  65 ;  effect 
on,  of  disturbed  political  or  indus¬ 
trial  conditions,  83-84 ;  demoraliza¬ 
tion  of,  by  the  European  war, 
107. 

Expenses  of  railroads,  analysis  of, 
III.  3-25  ;  comparative  importance 
of  general  expenses  and  fixed  charges 
on  railroads,  on  natural  waterways, 
and  on  canals,  29-31. 

Expenses  of  water  transportation, 
classification  of,  III.  25  ff. ;  those 
which  pertain  to  movement  of  traffic, 
25-26;  terminal  expenses,  26;  gen¬ 
eral  expenses,  26-27 ;  fixed  charges, 
27-29. 

Explosives,  an  example  of  goods  for 
which  higher  transportation  rates 
can  be  charged  than  for  other  goods, 
III.  161. 

Exportation  of  specie  and  the  rate  of 
exchange,  I.  107-m. 

Export  duties,  effect  of  high,  on  rate 
of  exchange,  I.  15 1;  consequences 
of,  when  levied  for  revenue,  II. 
52-55 ;  effect  of  protective,  on  a 
country’s  trade,  57-60;  effect  of, 
on  flow  of  specie  and  on  money 
prices  in  tax-levying  country,  69- 
70. 

Export  Rate  case,  III.  164. 

Export  trade,  influence  of  rate  of 
exchange  on,  I.  118-119;  injury 
resulting  to  a  country’s,  from  policy 
of  protection,  II.  58-59;  competi¬ 
tion  of  indirect  routes  for,  III.  46; 
competition  of  directions  illustrated 
by,  from  United  States  to  South  and 


INDEX 


197 


East  African  ports,  59-60;  distinc¬ 
tion  between  discriminating  rates 
in  favor  of,  and  sales  at  lower  prices 
abroad  of  tariff-protected  American- 
made  goods,  148  n. 

F 

False  billing,  discrimination  by  means 
of,  III.  176,  177. 

Farmers,  a  tariff  for  benefiting  wage- 
earners  at  expense  of,  II.  100-110; 
home  market  argument  for  pro¬ 
tection  addressed  to,  1 24-1 27. 

Federal  Reserve  Act,  provisions  of, 
relative  to  national  bank  notes,  I. 
42-43;  function  of  Federal  reserve 
banks  established  by,  47  ;  provisions 
of,  for  suspending  reserve  require¬ 
ments,  48;  rediscounting  permitted 
and  encouraged  by,  73. 

Federal  reserve  banks,  reserves  kept 
by,  I.  47. 

Fiat  money,  I.  8,  13. 

Fighting  ships,  use  of,  to  prevent 
competition  in  water  transportation, 
III.  80-81. 

Finance  bills,  I.  90-93. 

Financial  disturbances,  influence  of, 
on  rate  of  exchange,  I.  113-114. 

Finished  products,  proper  relation  of 
rates  on,  to  rates  on  raw  materials, 
III.  164-165. 

Firsts  and  seconds,  explanation  of 
terms,  applied  to  drafts,  I.  128. 

Fisher,  Irving,  Elementary  Principles 
of  Economics,  cited,  I.  5,  17,  II.  5, 
III.  9  n.,  17  ;  The  Purchasing  Power 
of  Money,  cited,  I.  14,  19,  22,  28,  43, 
45,  137,  II.  67. 

Fisk,  International  Commercial  Policies, 
cited,  II.  15 1. 

“Five  Per  Cent  Case,”  cited,  III.  89, 
90,  91. 

Fixed  charges,  as  one  class  of  railroad 
expenses,  III.  10;  what  is  included 
in,  10-n;  relative  importance  of, 
n-12;  independence  of  traffic,  12; 
relative  magnitude  of,  12-13  ;  ques¬ 
tion  of  influence  of,  on  railroad 
rates,  18-24  >  relation  of,  to  expenses 
and  rates  of  water  transportation, 
27-29;  comparative  importance  of 
general  expenses  and,  on  railroads, 


on  natural  waterways,  and  on 
canals,  29-31 ;  may  be  an  element  in 
making  carriage  of  goods  by  a  round¬ 
about  route  economically  justifiable, 
41- 

Flour,  relative  rates  for  carrying  wheat 
and,  III.  164-165. 

Foreign  exchange,  nature  and  method 
of,  I.  51  ff. 

France,  protection  of  gold  reserve  by, 
during  European  war,  I.  149-150. 

Free  trade,  meaning  of,  II.  39-40; 
advantages  to  countries  adhering  to 
principles  of,  80-83 ;  wages  and 
prices  under  protection  and,  com¬ 
pared,  96;  condition  of,  between 
States  of  United  States  an  argument 
for  successful  operation  of,  between 
nations,  137-138.  See  Revenue 
tariff. 

Fuller,  Herbert  Brace,  “American 
Waterways  and  the  Pork  Barrel,” 
cited,  II.  176,  179. 

Futures,  speculation  in,  in  foreign 
exchange,  I.  98-99. 

G 

General  expenses,  what  is  included  in, 
in  case  of  railroads,  III.  8-10 ;  influ¬ 
ence  of,  in  determining  railroad  rates, 
16-18;  relation  of,  to  expenses  and 
rates  of  water  transportation,  26- 
27 ;  comparative  importance  of 
fixed  charges  and,  on  railroads,  on 
natural  waterways,  and  on  canals, 
29-31. 

Geographical  specialization  in  pro¬ 
duction  of  goods,  II.  8-9;  inter¬ 
ference  with,  under  conditions 
created  by  a  protective  tariff,  62- 
63- 

George,  Henry,  Protection  and  Free 
Trade,  cited,  II.  120. 

Germany,  success  of,  in  preventing 
depreciation  of  paper  money  during 
European  war,  by  prohibiting  ex¬ 
portation  of  gold,  I.  149  n. ;  com¬ 
parison  of  wages  and  prices  in  Eng¬ 
land  and,  II.  96 ;  argument  used  for 
protection  to  agriculture  in,  12  7-1 29 ; 
beet  sugar  bounty  in,  1 51-15  2  ;  con¬ 
clusions  concerning  waterway  sys¬ 
tem  of,  171. 


198 


INDEX 


Gold,  value  of  money  as  related  to 
value  of,  I.  21-22.  See  Specie. 

Goschen,  The  Theory  of  the  Foreign 
Exchanges,  cited,  I.  89,  92,  113,  13 1, 
134,  136,  140,  142,  143. 

Government,  function  of,  in  relation 
to  transportation  monopoly,  III. 
87-92. 

Government-owned  railroads,  discrim¬ 
ination  either  in  favor  of  or  against 
imports  by,  III.  107. 

Great  Britain,  advantages  secured  by 
policy  of  free  trade  in,  II.  81-83 ; 
system  of  harbor  improvement  and 
lighthouse  maintenance  followed  in, 
174-176. 

H 

Hadley,  Economics,  cited,  I.  3,  7,  II. 
122  n..  III.  188;  Railroad  Trans¬ 
portation,  cited.  III.  17,  19,  66,  71, 
74,  169. 

Haney,  A  Congressional  History  of 
Railways  in  the  United  States,  cited, 
II.  182. 

Harbors,  uneconomic  improvement  of, 
at  public  expense,  II.  172  ff. ;  British 
system  of  improvement  and  main¬ 
tenance  of,  174-176. 

Harbor  trusts  in  Great  Britain,  II. 

1 74-1 75,  III.  86. 

Hart,  A.  B.,  Essentials  in  American 
History,  cited,  II.  138.  j 

Holding  companies  prohibited  under 
Clayton  Act,  III.  72. 

Home  market  argument  for  protection, 
II.  1 24-1 27. 

Hooper,  Railroad  Accounting,  cited,  III. 
3- 

Huebner,  “Report  on  Steamship  Agree¬ 
ments  and  Affiliations  in  the  Ameri¬ 
can  Foreign  and  Domestic  Trade,” 
cited,  III.  59,  77,  78,  79,  80,  81,  83, 
84,  97,  175- 

I 

Immigration,  danger  to  wages  in 
United  States  from,  rather  than 
from  lack  of  protective  tariff,  II. 
121-122. 

Importation  of  specie  and  the  rate  of 
exchange,  I.  111-113. 


Importations,  influence  of  rate  oi 
exchange  on  amount  of,  I.  118-119. 

Import  duties,  effect  of  high,  on  rate  of 
exchange,  I.  152;  two  classes  of, 
H.  39 ,'  conditions  where,  when 
levied  for  revenue,  the  burden  is 
borne  by  the  levying  country,  41-43  ; 
shifting  of  burden  by  the  levying 
country  to  another  or  other  coun¬ 
tries,  44-51;  effect  of  protective, 
on  a  country’s  trade,  57  ff. ;  un¬ 
profitable  industries  set  up  at  the 
general  expense  by  protective,  60- 
66.  See  Protective  tariff. 

Import  trade,  competition  of  indirect 
routes  for,  III.  46 ;  uneconomy  of 
discrimination  in  rates  either  in  favor 
of  or  against,  103-108. 

Incomes,  loss  in  the  way  of,  resulting 
from  system  of  protection,  II.  68- 
69. 

Individualism,  philosophy  of,  applied 
to  use  of  finance  bills,  I.  92-93. 

Industrial  morality,  ideals  of,  violated 
by  discrimination  among  shippers, 
III.  185-191. 

Industrial  railroads,  as  a  device  for 
discriminating  among  shippers,  III. 
179-180. 

Inefficiency,  encouragement  of,  in 
some  degree,  by  protective  tariff, 
II.  80. 

Infant  industry  argument  for  pro¬ 
tection,  II.  1 29-134;  as  applied 
to  bounties,  153. 

Inland  Waterways  Commission,  Re¬ 
port  of,  cited,  III.  143. 

Insurance  rates  on  gold  shipments, 
I.  107. 

Intercommunity  trade,  II.  11-17; 
limits  to  fluctuations  of,  19  ff. 

Interest,  loss  of,  during  transportation 
of  gold,  I.  107-109 ;  relation  be¬ 
tween  rate  of,  and  price  of  long 
drafts,  126-127,  131-133;  statement 
of  theory  of,  II.  86;  effect  of  pro¬ 
tection  on  rate  of,  86-89. 

Intermountain  Rate  cases,  III.  141. 

International  Harvester  Company, 
terminal  railroad  device  employed 
by,  III.  179-180. 

nternational  trade,  distinction  be¬ 
tween  intranational  and,  one  of 
degree  only,  H.  16-17. 


INDEX 


199 


Interstate  Commerce  Commission, 
classification  of  railroad  expenses 
made  by,  III.  10  n. ;  decisions  of, 
concerning  rates  on  import  and  ex¬ 
port  trade,  47  ;  rulings  on  competi¬ 
tion  of  roundabout  routes,  47  ;  power 
of,  to  decide  in  each  case  of  deviation 
from  long  and  short  haul  rule,  49; 
protection  given  by,  against  evils 
of  monopoly  of  rail  competition,  75  ; 
quoted  concerning  premium  to  be 
placed  on  efficiency,  91 ;  power  of, 
to  deal  with  the  relation  between 
intrastate  and  interstate  rates,  115; 
ruling  as  to  discrimination  by  a 
transportation  company  in  favor 
of  traffic  moving  a  long  distance 
over  its  own  lines,  116,  1x7  ;  should 
exercise  its  power  to  relieve  certain 
roundabout  lines  of  requirements  of 
long  and  short  haul  clause,  126; 
decision  of,  concerning  water  com¬ 
petition,  in  St.  Louis  Business 
Men’s  League  case,  138-139  ;  power 
of,  to  correct  discrimination  in  favor 
of  exports,  146  n. ;  jurisdiction  of, 
over  cases  of  discrimination  among 
shippers,  182 ;  Special  Report  on 
Discrimination  and  Monopolies  in 
Coal  and  Oil,  cited,  183,  184; 

Reports  of,  cited,  39,  47,  58,  63,  89, 
90,  104,  109,  no,  1x6,  117,  138,  141, 
142,  146,  162-165,  175,  179. 

Interstate  Commerce  Law,  agreements 
between  rival  railroad  companies 
made  illegal  by,  III.  72,  75  ;  applied 
to  water  transportation  companies, 
82  ;  provisions  prohibiting  discrimi¬ 
nation  in  rates  among  places,  102  ; 
illegitimate  competition  of  railroads 
against  water  lines  penalized  by, 
143  ;  discrimination  among  shippers 
made  illegal  by,  182. 

Intrastate  business,  discrimination  in 
favor  of,  resulting  from  orders  of 
state  commissions,  III.  112-115. 

Intrastate  rates,  relation  of,  to  inter¬ 
state  rates,  under  control  of  Inter¬ 
state  Commerce  Commission,  III. 
115- 

Investment,  character  of,  as  a  part  of 
trade,  II.  29  n. 

Investments,  long  run  effect  of  in¬ 
ternational,  upon  rate  of  exchange 


and  flow  of  money,  I.  1 20-1 22; 
long  drafts  on  foreign  countries 
held  by  American  banks  as,  1 27-130. 

J 

Jacobs,  L.  M.,  “Bank  Acceptances” 
by,  cited,  I.  37  n.,  73. 

Johnson,  Ocean  and  Inland  Water 
Transportation ,  cited,  II.  173,  175; 
American  Railway  Transportation , 
cited,  182,  III.  50,  71,  72,  73. 

Joint  account,  investment  by  two 
banks  for,  I.  93-94. 

Joint  costs  of  traffic,  railroad  expenses 
classified  as,  III.  8-9. 

K 

Kemmerer,  Money  and  Credit  In¬ 
struments  in  their  Relation  to  General 
Prices,  cited,  I.  43. 

L 

Land.  See  Real  estate. 

Land  grants  to  railroads,  II.  182-186. 

Land  rent,  laws  of  wages  and,  II. 
89-92 ;  effect  of  protection  on 
wages  and,  under  varying  condi¬ 
tions,  93-110;  effect  of  bounties 
on,  152-153. 

Large  scale  production,  protective 
tariff  and,  II.  71-72. 

Laws  of  money,  I.  1  ff. 

Lenders,  viewed  as  persons  who 
provide  waiting,  I.  30-33 ;  ad¬ 
vantages  to,  of  system  of  com¬ 
mercial  banking,  34-35. 

Letters  of  credit,  analysis  of  relations 
involved  in,  I.  94-96. 

Levi,  The  History  of  British  Com¬ 
merce,  cited,  II.  70. 

Lighthouses,  maintenance  of,  by  a 
central  government,  II.  172,  175-176. 

Limping  standard,  conditions  for 
successful  operation  of  the,  I. 
19-21. 

Lindsay,  History  of  Merchant  Ship¬ 
ping,  cited,  II.  155. 

Loans,  short  time,  made  through 
intermediation  of  exchange  market, 
I.  85  ff. ;  sterling  and  currency, 
85-86. 


200 


INDEX 


Local  self-sufficiency,  competition  of 
railroads  against,  III.  64-65 ;  dis¬ 
crimination  among  places  by  a  rail¬ 
road  competing  with,  1 44-1 45. 
Locations,  competition  of,  III.  61-64. 
London,  the  world’s  financial  center, 

I.  63-64 ;  effect  on  disposal  of 
long  drafts  at  lower  discount  rate 
in,  than  in  New  York,  133. 

Long  drafts  or  bills,  I.  67 ;  sale  of 
demand  drafts  by  banks,  against 
remittances  of,  71  -73 ;  effect  on 
price  of,  of  rate  of  interest  or  dis¬ 
count,  126-127;  method  of  pro¬ 
cedure  when  held  as  investments 
by  American  banks,  1 27-130;  in¬ 
fluence  on  price  of,  of  interest 
rate  in  drawing  country  and  of 
interest  rate  in  country  drawn 
upon,  131-133. 

Lorenz,  M.  O.,  article  by,  cited.  III. 
140  n. 

Loria,  “Effects  of  Import  Duties  in 
New  and  Old  Countries,”  cited, 

II.  106. 

Lumber,  competition  of  locations  illus¬ 
trated  by  transportation  of,  III. 
63-64. 

M 

McPherson,  Railroad  Freight  Rates, 
cited,  III.  38,  65. 

Make-work  argument  for  protection, 
fallacy  of  the,  II.  12  2-1 24. 
Manufactures,  consequences  of  policy 
of  protection  to,  II.  73. 

Margraff,  International  Exchange, 
cited,  I.  70,  96  n.,  128,  130. 

Market  value  of  securities,  not  a 
satisfactory  standard  for  rate  fixing, 

III.  91. 

Marks,  Lawrence  M.,  statistics  of  rate 
of  exchange  compiled  by,  I.  83  n. 
Marshall,  memorandum  on  effect  in 
international  trade  of  different  cur¬ 
rencies,  I.  141  n. ;  Principles  of  Eco¬ 
nomics,  cited,  III.  22,  89  n. 

Mason,  “The  American  Silk  Industry 
and  the  Tariff,”  cited,  II.  130. 

Meeker,  R.,  History  of  Shipping 
Subsidies,  cited  and  quoted,  II. 
i45>  iS9,  161,  162. 

Meyer,  H.  R.,  Government  Regulation 


of  Railway  Rates,  cited,  III.  107 
108. 

Military  argument,  for  protective 
tariff,  to  insure  national  self- 
sufficiency,  II.  135-137;  for  ship¬ 
ping  subsidies,  as  a  means  of  in¬ 
creasing  a  nation’s  naval  strength, 
161-162 ;  for  building  Panama 
Canal,  168. 

Mill,  J.  S.,  Principles  of  Political 
Economy,  cited,  I.  5,  II.  21,  24,  25, 
26,  45»  46>  52,  74>  HI-  186;  System 
of  Logic,  cited,  II.  120. 
Mismanagement  of  transportation 
company,  governmental  regulation 
not  to  be  affected  by  element  of, 
III.  89. 

Mississippi  River,  unwise  expenditure 
of  money  in  improvement  of,  II. 
176-177. 

Monetary  standards,  effect  of  differ¬ 
ent,  on  exchange  between  two 
countries,  I.  138-142 ;  rate  of 
interchange  of  goods  between  coun¬ 
tries  not  affected  by  difference 
in,  II.  24-25. 

Money,  laws  of,  I.  1  ff. ;  position  of, 
as  a  medium  of  exchange,  2-3 ; 
relation  between  prices  and,  3 ; 
causal  explanation  of  value  or 
“purchasing  power”  of,  12-16; 
theory  of  bimetallism,  16-18;  value 
of  subsidiary,  19-21;  relation  of 
value  of,  to  value  of  a  standard 
money  metal,  21-22;  relation  be¬ 
tween  level  of  prices  and  value  of, 
in  one  country  or  locality  and  level 
of  prices  and  value  of,  in  another, 
22-24;  substitution  of  credit  for, 
26-27  5  reasons  why  bank  credit 
is  able  to  displace,  as  a  medium  of 
exchange,  33  ff. ;  relation  of,  to¬ 
gether  with  bank  credit,  to  prices, 
43-45  5  substitutes  for,  in  inter¬ 
national  and  long-distance  trade, 
52  ;  cost  of  shipment  of,  in  domestic 
exchange,  115-116;  fallacy  of  the 
argument  for  protection,  that  it 
keeps  money  in  the  protected 
country,  II.  116-118;  argument 
for  shipping  subsidies  based  on, 
158. 

Monopolies,  differing  prices  of  goods 
of,  at  home  and  abroad,  II.  4  n. ; 


INDEX 


201 


protective  system  as  an  encourage¬ 
ment  to,  1 13  ;  built  up  by  discrimi¬ 
nation  among  shippers,  III.  185-186. 

Monopolistic  transportation  rates,  eco¬ 
nomic  objections  to,  III.  33-34; 
higher  in  proportion  to  distance  or 
service  rendered,  than  competitive 
rates,  67-68 ;  may  prevent  com¬ 
merce  which  is  economically  desir¬ 
able,  68;  devices  for  securing,  71- 
72  ;  made  illegal,  72. 

Monopoly,  devices  for  securing,  in 
water  transportation,  III.  75-86 ; 
function  of  government  in  relation 
to,  87-92. 

Moulton,  Waterways  versus  Railways, 
cited,  II.  1 71. 

N 

National  banks,  guaranteeing  of  notes 
issued  by,  by  Federal  government, 

I.  41-42 ;  foreign  exchange  business 
of,  65-66. 

Naval  reasons  for  shipping  subsidies, 

II.  161-162. 

Navigation  companies,  agreements 
among,  and  governmental  regula¬ 
tion  of,  III.  75-83  ;  agreements  be¬ 
tween  railway  companies  and,  83- 
84 ;  rate  discrimination  between 
places  by,  97. 

Navigation  laws,  II.  155-156;  analo¬ 
gous  to  protective  tariffs,  156-157. 

Newcomb,  Principles  of  Political 
Economy,  cited,  I.  3. 

Noyes,  American  Railroad  Rates,  cited, 

III.  50. 

P 

Pacific  Coast  points,  discrimination  in 
favor  of,  III.  138-139. 

Panama  Canal,  question  of  indirectly 
subsidizing  American  ships  by 
allowing  them  free  use  of,  II.  163 ; 
lack  of  economic  justification  for 
plan  of  allowing  American  coast¬ 
ing  trade  free  use  of,  165-169. 

Panama  Canal  Act  of  1912,  III.  83; 
effect  on  railroad  ownership  of  ves¬ 
sels,  86. 

Panics,  effect  of,  on  bank  credit,  I. 
46-47 ;  lowering  of  rate  of  ex¬ 
change  due  to,  113-114;  effect  of, 


in  one  country  on  discount  rate 
and  flow  of  specie  in  other  coun¬ 
tries,  137-138. 

Paper  money,  exchange  between 
countries  under  existence  of,  as  an 
inconvertible  standard,  I.  142-147 ; 
success  of  belligerent  countries  in 
European  war  in  preventing  depre¬ 
ciation  of,  by  prohibiting  export  of 
gold,  149  n. 

Parasitic  industries,  establishment  of, 
by  protective  tariff,  II.  60-66. 

Par  of  exchange,  I.  77-78;  establish¬ 
ment  of  a  new,  between  countries 
with  different  monetary  standards, 
139- 

Patten,  Economic  Basis  of  Protection, 
cited,  II.  106. 

“Pauper  labor”  argument  used  by 
protectionists,  II.  1 19-120. 

Pennsylvania  Railroad  system,  dis¬ 
crimination  in  favor  of  coal  com¬ 
panies  by,  III.  183-184. 

Pigou,  cited  concerning  theory  that 
railroad  transportation  is  a  business 
of  joint  costs,  III.  9  n. ;  article  on 
“Railway  Rates  and  Joint  Costs,” 
cited,  170. 

Place  speculation  in  exchange,  I. 
96-97. 

Plate  glass,  discrimination  in  rates 
practiced  against  domestic,  III.  104. 

Politics,  part  taken  by,  in  the  pro¬ 
tection  of  infant  industries,  II. 
1 3  2-1 33;  operation  of,  in  American 
waterway  development,  178-181. 

Pooling  devices  adopted  by  railroad 
companies,  III.  71-72;  laws  passed 
against,  72-73 ;  arguments  for,  when 
properly  supervised,  74-75 ;  desira¬ 
bility  of,  under  some  circumstances, 
when  supervised  by  Interstate  Com¬ 
merce  Commission,  103. 

Population,  density  of,  and  rate  of 
wages,  II.  1 20-1 21. 

“Pork  barrel”  system  of  waterway 
development,  II.  178-181. 

Preferential  agreements  between  rail¬ 
way  and  steamship  lines,  III.  83-84. 

Prices,  quantitative  statement  of 
relation  between  money  and,  I. 
3-4 ;  causal  explanation  of,  of 
given  kinds  of  goods,  5-8;  causal 
explanation  of  general  level  of,  8-12; 


202 


INDEX 


relation  between  level  of,  and 
value  of  money  in  one  country  or 
locality  and  level  of,  and  value  of 
money  in  another,  22—24;  relation 
of  money,  together  with  bank 
credit,  to,  43—45 ;  influence  of,  in 
the  long  run,  on  the  exchange 
market,  116-120;  affected  by  bank 
discount  rate,  135-136;  effect  of 
a  panic  in  one  country  on  level  of, 
in  other  countries,  137-138;  effect 
on,  of  different  currencies  in  two 
different  countries,  138-142;  tend¬ 
ency  of,  through  influence  of  trade, 
toward  equality  in  different  coun¬ 
tries,  II.  3-7;  tendency  of,  to  be 
lower  in  the  country  where  goods 
can  be  produced  with  greatest  rela¬ 
tive  advantage,  7-1 1;  high  rate  of 
wages  does  not  imply  high,  9;  ef¬ 
fects  of  protective  tariff  on,  67-70, 
74-78;  effect  of  bounties  on  level 
of,  in  bounty-paying  countries,  146- 
148;  effect  of  artificial  navigation 
laws  on,  156. 

Producing  corporations,  discrimination 
arising  from  railroad  ownership  of 

in.  183-185. 

Promissory  notes,  use  of,  for  money, 

I.  26-27. 

Protection.  See  Protective  tariff. 

Protective  tariff,  effect  of,  on  rate 
of  exchange,  I.  150-15  2  ;  distinction 
between  revenue  tariff  and,  II. 
39— 41  j  effect  of,  on  a  country’s 
export  trade,  57-60;  how  unprofit¬ 
able  industries  are  set  up  at  the 
general  expense  by,  60-66;  view 
of,  as  “mutual  tribute,”  64;  effect 
of,  on  money  prices  of  protected 
and  of  unprotected  goods,  67-70; 
improbability  of  increase  of  national 
wealth  by,.  71  n. ;  operation  of,  as 
to  industries  in  which  large  scale 
production  is  advantageous,  71— 

72 ;  applied  to  industries  of  in¬ 
creasing  cost,  72-74;  effect  on 
cost  of  unprotected  goods  got  from 
other  countries,  74-78;  chimerical 
proposition  as  to  establishing  a 
tariff  equal  to  the  difference  in 
cost  of  production  at  home  and 
abroad,  together  with  a  reasonable 
profit,  79-80;  not  necessarily 


conducive  to  efficiency  in  methods 
of  production,  80;  relative  advan¬ 
tages  in  world’s  commerce  of 
countries  having  high  and  countries 
having  low  or  no  tariffs,  80-83; 
effect  on  rate  of  interest  and  there¬ 
fore  on  wages,  86-89;  effect  of, 
on  wages  and  rent  under  varying 
conditions,  97-no;  may  benefit 
one  section  of  a  country  at  the  ex¬ 
pense  of  other  sections,  111-113; 
as  an  encouragement  to  monopoly’ 
1 13  ;  the  argument  for,  that  it  keeps 
money  in  the  protected  country, 
116-118;  the  wages  argument  for, 
118—122;  the  make-work  argument, 

1 2 2-1 24;  the  home  market  argu¬ 
ment,  124— 127;  the  infant  industry 
argument,  .129-134;  diversification 
of  industries  argument,  134-135 ; 
argument  concerning  national  self- 
sufficiency,  1 3  5-13  7  5  successful 
working  of  free  trade  between  States 
of  United  States  an  argument  against, 
x3  7-138 ;  ethical  considerations 
bearing  on  question  of,  139 ;  boun¬ 
ties  as  compared  and  contrasted 
with,  144— 145 ;  analogy  between 
navigation  laws  and,  156—157*  points 
of  similarity  of  shipping  subsidies 
and,  157-158;  rate  discriminations 
analogous  to,  III.  101,  105,  112-115, 
189;.  superficial  resemblance  of  dis¬ 
crimination  in  favor  of  export  traffic 
to  sale  abroad  at  lower  prices  of  goods 
protected  by,  148  n. 

Purchasing  power  of  money,  a  phrase 
used  to  express  the  price  of  money, 

I.  12-13;  explanation  of,  13-16. 

Q 

Quantity  theory  of  money,  I.  3-4. 

R 

Railroads,  comparison  of  canals  and, 
as  to  economy,  II.  1 70-1 72;  com¬ 
parison  of  transportation  costs  on 
rivers  and,  177-178;  subsidies  to 
building  of,  181-186;  error  made 
in  giving  municipal  or  local  aid  to, 
186;  analysis  of  expenses  of,  III.’ 

3  ff. ;  four  classes  of  expenses,  5 ; 


INDEX 


203 


expenses  for  production  of  train 
mileage,  6-8;  terminal  expenses,  8; 
general  expenses,  8-10;  classifica¬ 
tion  of  expenses  made  by  Interstate 
Commerce  Commission,  10  n. ;  fixed 
charges  or  sunk  costs,  10-13 ;  ex¬ 
tent  to  which  law  of  decreasing  cost 
applies  to  business  of,  13-14 ;  influ¬ 
ence  of  four  classes  of  expenses  on 
determination  of  rates,  14  ff. ;  in¬ 
fluence  of  expenses  for  production 
of  train  mileage,  14-15  ;  influence  of 
terminal  expenses,  15-16;  influence 
of  general  expenses,  16-18 ;  influence 
of  fixed  charges  or  sunk  costs,  18-24 ; 
effect  of  degree  of  utilization  of  rail¬ 
road  capital,  24-25 ;  comparative 
importance  of  general  expenses  and 
fixed  charges  on,  and  on  natural 
waterways  and  canals,  29-31 ;  pref¬ 
erential  agreements  between  steam¬ 
ship  lines  and,  83-84 ;  legislation 
concerning  competition  of,  with 
water  lines,  86 ;  economically  unde¬ 
sirable  rate  discrimination  among 
places  by,  94-96;  economic  loss 
which  may  flow  from  discrimination 
by,  among  places,  97-103  ;  unecon¬ 
omy  of  discrimination  by,  either  in 
favor  of  or  against  imports,  103- 
108 ;  when  discrimination  among 
places  by,  is  economically  justifiable, 
120  ff.;  discrimination  among  places, 
by  a  roundabout  line,  1 20-1 27; 
discrimination  by  the  longer  or  long¬ 
est  line,  when  there  is  competition 
of  directions  or  of  locations,  127- 
130;  discrimination  by  the  shorter 
or  shortest  line,  when  such  a  line 
has  comparatively  light  traffic,  130- 
132  ;  discrimination  among  places, 
by  railroads  competing  with  water 
lines,  1 3  2-1 43  ;  illegitimate  compe¬ 
tition  practiced  by,  against  water 
lines,  143 ;  discrimination  among 
places  by  a  railroad  competing  with 
local  self-sufficiency,  144-145 ;  dis¬ 
crimination  in  favor  of  export  traffic, 
145-153  ;  possible  loss  to,  from  carry¬ 
ing  discrimination  in  favor  of  ex¬ 
ports  too  far,  151-152;  discrimina¬ 
tion  between  two  opposite  directions 
by,  economically  desirable  within 
certain  limits,  153-156;  discrimi¬ 


nation  among  different  kinds  of 
goods,  160-173;  discrimination 
among  shippers,  175-191. 

Railroad  wages,  study  of,  II.  96  n. 

Rate  agreements  among  railroad  com¬ 
panies,  III.  71;  forbidden  by  law, 
72 ;  desirability  of,  under  some  cir¬ 
cumstances,  when  supervised  by  In¬ 
terstate  Commerce  Commission,  103. 

Rate  of  exchange,  I.  77  ff. ;  causes 
of  fluctuation  in,  78;  effect  on,  of 
disturbed  political  or  industrial 
conditions,  83-84;  short  time  loans 
and,  85-90;  upper  limit  to  fluctua¬ 
tion  of,  determined  by  cost  of 
exporting  specie,  103-107 ;  lower 
limit  to  fluctuation,  determined 
by  cost  of  importing  specie,  in- 
113  ;  influence  of  panics  or  financial 
disturbances  on,  1x3-114;  long 
run  effects  on,  of  a  balance  of  pay¬ 
ments  from  one  country  to  another, 
1 16  ff. ;  long  run  effect  of  inter¬ 
national  investments  on,  120-122; 
long  run  effect  of  payments  for 
various  purposes  on,  122-124;  when 
one  of  two  countries  has  a  gold  and 
the  other  a  silver  standard,  138-142  ; 
when  one  of  two  countries  has  a  gold 
and  the  other  an  inconvertible  paper 
standard,  14  2-1 44 ;  conditions  as 
to,  in  case  of  prohibition  of  specie 
shipment,  147-15  2 ;  effect  on,  of 
high  import  and  export  duties,  152. 

Rate  of  interchange  of  goods  between 
communities,  II.  19  ff. ;  determina¬ 
tion  of,  by  conditions  of  supply 
and  demand,  22-25 ;  effect  on, 
when  one  country  offers  a  variety 
of  goods,  26-27 ;  effect  when  one 
country  receives  periodic  payments 
of  obligations  from  another,  27- 
29;  effect  of  production  in  any 
country  under  conditions  of  differ¬ 
ent  cost,  29-32  ;  under  conditions 
involving  more  than  two  countries, 
32-35  ;  tariffs  and,  39  ff. 

Rate  of  interest,  effect  of  protection 
on,  II.  86-89. 

Rates  of  transportation,  influence  of 
the  four  classes  of  railroad  expenses 
on,  III.  14-25  ;  causes  which  affect, 
in  water  transportation,  25-29; 
economic  objections  to  monopolistic, 


204 


INDEX 


33-34  ’>  effect  of  competition  of  rail¬ 
road  companies  on,  37—40;  compe¬ 
tition  of  transportation  companies 
and,  37-7o;  function  of  govern¬ 
ment  relative  to  regulation  of,  87- 
91 ;  value  of  stocks  and  bonds,  and 
physical  valuation  of  transporta¬ 
tion  plant,  to  be  considered  in  fixing, 
91—92 ;  discrimination  in,  among 
places,  caused  by  competition,  94- 
96;  economic  loss  which  may  flow 
from  discrimination  in,  among  places, 
97—103  ;  uneconomy  of  discrimina¬ 
tion  in,  either  in  favor  of  or  against 
imports,  103-108 ;  uneconomy  of 
the  basing-point  system,  1 08-11 1; 
discrimination  in  favor  of  intrastate 
business,  resulting  from  orders  of 
state  commissions,  112-115;  dis¬ 
crimination  by  a  transportation  com¬ 
pany  in  favor  of  traffic  moving  a 
long  distance  over  its  own  lines,  115- 
117;  economically  defensible  dis¬ 
crimination  in,  among  places,  1 20  ff .  ; 
question  as  to  defensibility  of  dis¬ 
crimination  in,  among  different  kinds 
of  goods,  160-173. 

Raw  materials,  proper  relation  between 
rates  on  finished  products  and.  III. 
164-165. 

Real  estate,  principles  governing  value 
of  terminal,  III.  22,  23;  principle 
governing  use  of,  for  canals,  31; 
due  allowance  for  rent  of,  to  be  made 
in  governmental  regulation  of  trans¬ 
portation  rates,  88-89. 

Rediscounting  bills  of  exchange,  I. 
71-72;  not  practiced  in  United 
States,  72-73. 

Rent.  See  Land  rent. 

Rent  of  wharf  area,  determination  of, 
HI.  31-33. 

Reserves  in  banks,  I.  42,  44. 

Revenue  tariff,  II.  39  ff.  •  conditions 
under  which  it  is  borne  by  the 
levying  country,  41-43;  shifting 
of  burden  by  the  levying  country 
to  another  or  other  countries,  44- 
51 ;  consequences  of  a,  on  exports, 
52-55. 

Ripley,  W.  Z.,  Railroads,  Rates  and 
Regulation,  cited.  III.  39,  50, 141,169. 

Risk  in  carrying,  an  element  in  fixing 
of  rates.  III.  161. 


Rivers,  uneconomic  improvement  of, 
by  United  States,  II.  176-181. 
Roundabout  routes,  generally  un¬ 
economic  character  of  competition 
of,  III.  39-40;  situations  which 
render  desirable  or  justifiable  car¬ 
riage  of  goods  by,  in  preference  to 
shorter  routes,  40—47 ;  rulings  of 
Interstate  Commerce  Commission 
concerning,  47  ;  in  the  case  of  ocean 
transportation,  49 ;  economically 
defensible  discrimination  among 
places  by,  1 20-1 27. 

Routes,  competition  of,  of  transporta¬ 
tion  companies,  III.  37  ff. 

S 

St.  Louis  Business  Men’s  League  case 
HI.  138-139. 

Salt-producing  points,  competition  of 
directions  illustrated  by,  III.  58. 
Sanborn,  Congressional  Grants  of  Land 
in  Aid  of  Railways,  cited,  II.  182. 
Savannah  Naval  Stores  case,  III.  116. 
S  chillier,  discussion  of  arguments  of, 
relative  to  protection,  II.  124  n. 
Seasonal  variations  of  trade,  desira¬ 
bility  of  elasticity  in  bank  currency 
to  meet,  I.  48,  50. 

Secret  rates,  a  means  of  discriminating 
among  shippers,  III.  177-179. 
Self-sufficiency,  argument  for  protec¬ 
tion  in  order  to  get  and  maintain 
national,  II.  135-137. 

Selling  short  in  foreign  exchange,  I. 
99-100. 

Sherman  Anti-trust  Act,  effect  of,  on 
monopoly  rates,  III.  72 ;  applied  to 
agreements  between  navigation  com¬ 
panies,  81. 

Shippers,  discrimination  among,  III. 
175  ff-,*  methods  of  practicing  and 
of  concealing  discrimination  among, 
175-180. 

Shipping,  navigation  laws  designed 
to. encourage,  II.  155-157;  adver¬ 
tising  value  of,  159-160. 

Shipping  subsidies,  II.  144;  shown 
to  be  without  economic  justifica¬ 
tion,  157-162;  naval  reasons  for, 
161-162;  indirect,  favoring  native 
ships  as  compared  with  foreign 
ships,  163-165. 


INDEX 


205 


Short  time  loans  made  through  the 
exchange  market,  relations  involved 
in  and  results  of,  I.  85-90. 

Shreveport,  La.,  case,  III.  112-115. 

Sidgwick,  views  of,  on  protection, 
II.  107  n. 

Sight  drafts,  I.  67 ;  rate  on,  constitutes 
the  pure  rate  of  exchange,  126; 
relation  between  bank  discount 
rate  and  price  of,  133-136. 

Silk  industry  in  United  States,  an 
example  of  infant  industry  argu¬ 
ment,  II.  130. 

Smith,  J.  R.,  The  Organization  of  Ocean 
Commerce,  cited,  II.  174,  III.  1 55, 
162,  171. 

Southern  states,  effect  of  protective 
system  on  the,  II.  112. 

Space  occupied,  an  element  for  con¬ 
sideration  in  fixing  of  rates,  III.  161. 

Specie,  rate  of  exchange  and  the 
flow  of,  I.  103  ff. ;  upper  limit  to 
fluctuation  of  rate  of  exchange 
determined  by  cost  of  exporting, 
103-107 ;  details  connected  with 
exportation  of,  107-m;  lower 
limit  to  fluctuation  of  rate  of  ex¬ 
change  determined  by  cost  of  im¬ 
porting,  111-113;  long  run  effects 
on  flow  of,  of  a  balance  of  payments 
from  one  country  to  another, 
1 16  ff. ;  long  run  effects  on  flow 
of,  of  international  investments, 
120-122;  effect  of  bank  discount 
rate  on  price  of  demand  drafts  and 
the  flow  of,  133-136 ;  flow  of,  abroad 
prior  to  outbreak  of  European  war, 
136  n. ;  effect  of  panics  on  flow  of, 
137-138;  effect  on  flow  of,  of  dif¬ 
ferent  currencies  in  two  countries, 
138  ff. ;  exchange  between  two  coun¬ 
tries,  assuming  prohibition  of  ship¬ 
ment  of,  147-152. 

Speculation  in  foreign  exchange,  I. 
96-100. 

State  railroad  commissions,  rate  dis¬ 
crimination  resulting  from  orders 
of,  III.  1 1 2-1 1 5. 

Station  expenses.  See  Terminal  ex¬ 
penses. 

Steamship  lines.  See  Navigation  com¬ 
panies. 

Sterling  loans,  I.  85-86. 

Stock  exchange,  New  York,  closing 


of,  to  impede  flow  abroad  of  specie, 
I.  136  n. 

Subsidiary  money,  conditions  deter¬ 
mining  successful  employment  of, 
I.  19-21. 

Subsidies,  to  shipping,  II.  144,  157- 
165;  to  railroad  building,  181-186. 

Sumner,  William  Graham,  Protection¬ 
ism,  cited,  II.  61,  82,  126,  136, 
152;  quoted,  64,  65,  134. 

Sunk  costs,  of  railroads,  III.  n-12; 
question  of  influence  of,  on  railroad 
rates,  18-24;  in  the  case  of  water 
transportation,  27-29. 

Supply  and  demand,  relation  between 
price  of  a  given  kind  of  goods  and, 
I.  5-8;  application  of  principles  of, 
to  the  general  level  of  prices,  8- 
1 2 ;  applied  to  money  and  prices, 
13-16 ;  effects  of  laws  of,  on  various 
monetary  systems,  16;  price  of 
bills  of  exchange  or  drafts  deter¬ 
mined  by,  77;  forces  affecting,  of 
bills  of  exchange,  78-83  ;  conditions 
of,  determining  rate  of  interchange 
of  goods  between  countries,  II.  22- 
25- 

Supreme  Court,  decision  by,  concern¬ 
ing  power  of  Congress  to  deal  with 
relation  of  intrastate  and  interstate 
rates  as  a  relation.  III.  115. 

Switching  charges,  discrimination  by 
use  of  device  of,  III.  180. 

T 

Tank  cars,  special  rates  for,  a  device 
for  discrimination  among  shippers, 
III.  177-178. 

Tarbell,  Ida  M.,  The  History  of  the 
Standard  Oil  Company,  cited.  III. 
181. 

Tariffs,  effect  of,  on  location  of  in¬ 
dustries,  II.  xx ;  revenue  and  pro¬ 
tective,  distinguished,  39-41.  See 
Protective  tariff  and  Revenue  tariff. 

Taussig,  Principles  of  Economics, 
cited,  I.  1 1 5,  1 21,  II.  7,  23,  27,  74, 
hi,  127,  III.  137;  article  by,  cited, 
III.  9. 

Terminal  expenses  of  railroads,  III.  5 ; 
what  is  included  in,  8 ;  variation  of, 
with  amount  of  freight  and  number 
of  passengers  carried,  8;  influence 


206 


INDEX 


of,  in  determining  railroad  rates, 
15-16;  influence  of,  on  expenses 
of  water  transportation,  26. 

Terminal  railroads,  employed  as  a 
device  for  discriminating  among 
shippers.  III.  179-180. 

Texas  Railroad  Commission,  rate  dis¬ 
crimination  in  favor  of  intrastate 
business  resulting  from  orders  of,  III. 
112. 

Time  drafts,  I.  127. 

Time  speculation  in  exchange,  I. 
97-100. 

Trade,  primitive,  I.  1 ;  money  as  a 
part  of  the  mechanism  of,  1-2  ; 
conditions  governing  intercommu¬ 
nity,  II.  11-16;  international  com¬ 
pared  with  intranational,  16-17; 
conditions  regulating  rate  of,  be¬ 
tween  communities,  19  ff. ;  supply 
and  demand  as  the  determining 
factor  in,  22-25 ;  effect  on  rate  of, 
when  one  country  offers  a  variety 
of  goods  and  when  it  receives  peri¬ 
odic  payments  of  obligations  from 
the  other,  26-29;  influence  of  pro¬ 
duction  in  any  country  under  condi¬ 
tions  of  different  cost,  29-32;  effect 
of  entrance  of  an  additional  country 
into,  32-35  ;  cost  of  transportation 
as  related  to,  36;  revenue  tariffs 
and,  39-56 ;  effects  of  a  protective 
tariff,  57  ff.  See  also  Rate  of  inter¬ 
change  of  goods. 

Trade  follows  the  flag  ’  ’  argument 
for  shipping  subsidies,  II.  159. 

Traffic  agreements  among  navigation 
companies,  III.  75-81. 

Train  mileage,  expenses  of  railroads 
for  production  of,  III.  6 ;  degree  of 
variation  of,  with  amount  of  traffic, 
7-8;.  influence  of,  on  determination 
of  railroad  rates,  14-15. 

Tramp  vessels,  variation  of  expenses  of, 
with  amount  of  business,  III.  25- 
26 ;  profits  of,  not  necessarily  uni¬ 
form  in  relation  to  fixed  charges,  27- 
28 ;  a  means  of  checking  monopoly 
in  water  transportation,  77  ;  reason¬ 
able  rates  in  water  transportation 
insured  by  competition  of,  176. 

Transcontinental  business,  economi¬ 
cally  defensible  discrimination  among 
places  in,  III.  140-142. 


Transportation,  cost  of,  of  money, 
in  domestic  exchange,  I.  115-116; 
cost  of,  as  related  to  trade,  II.  36; 
navigation  laws  and  shipping  sub¬ 
sidies  for  encouragement  of,  by 
water,  155  ff. ;  comparison  of  rail¬ 
roads  and  canals  for  purposes  of, 
170-172;  comparison  of  cost  of, 
on  railroads  and  on  rivers,  177-178; 
discussion  of  cost  of,  III.  3-36. 

U 

Utilization  of  transportation  plant, 
relation  between  railroad  expenses 
and,  III.  13-14;  railroad  rates  as 
affected  by  degree  of,  24-25;  as  a 
test  of  relative  rates,  165-173. 

V 

Value  of  commodity,  element  of,  in 
rate  fixing,  III.  169-171. 

Variety  of  goods,  advantages  to 
country  offering,  for  export,  II. 
26-27. 

Velocity  of  circulation,  relation  be¬ 
tween  supply  of  money  and,  I. 

13-14- 

W 

Wages,  high  rate  of,  does  not  imply 
that  goods  cannot  be  produced  and 
exported  at  low  money  cost,  II.  9; 
reduction  of,  resulting  from  rise 
in  rate  of  interest  due  to  protective 
policy,  88-89;  laws  of  wages  and 
land  rent,  89-92 ;  effect  of  protec¬ 
tion  on,  when  protected  and  un¬ 
protected  goods  are  produced  under 
conditions  of  substantially  constant 
cost,  93-96;  effect  of  bounties  on, 

152-153. 

Wagner,  Adolph,  Agrar-und  Industrie- 
staat,  cited,  II.  127. 

Waiting,  element  of,  provided  by 
depositors  or  lenders,  in  commer¬ 
cial  banking,  I.  30-33. 

Walker,  Political  Economy,  cited,  I.  13. 

Wampum,  medium  of  exchange  among 
Indians,  I.  1. 

War,  the  European,  and  the  exchange 
market,  I.  107,  149— 150;  effect  on 
flow  of  specie  to  Europe,  136  n. 


INDEX 


207 


Warburg,  Paul  M.,  “The  Discount 
System  in  Europe,”  cited,  I.  37  n. ; 
quoted,  72  n. 

Water  frontage,  control  of,  by  railroad 
interests,  as  a  means  of  preventing 
competition,  III.  84-86. 

Water  lines,  provisions  of  Panama 
Canal  Act  relating  to  railroads  and, 
III.  86 ;  discrimination  among 
places  resulting  from  competition 
of  railroads  with,  132-143 ;  illegiti¬ 
mate  competition  by  railroads 
against,  143  ;  discrimination  among 
shippers  practiced  to  a  certain  extent 
by,  175-176. 

Water  transportation,  expenses  and 
rates  of,  III.  25-29;  roundabout 
routes  in  the  case  of,  49 ;  competition 
of  directions  in,  59-60;  devices  for 
preventing  competition  in,  75—86 ; 
rate  discrimination  between  places 
in,  97 ;  higher  rates  charged  for 
carrying  valuable  goods  in,  171. 

Waterways,  comparative  importance 
of  general  expenses  and  fixed  charges 


on  railroads,  canals,  and,  III.  29- 
31. 

Weighted  average,  defined,  II.  5. 

Weight  of  goods,  an  element  in  fixing 
of  transportation  rates,  III.  161. 

Wharf  charges,  proper  basis  of,  III.  31- 
33- 

Wharves,  control  of  space  for,  a  means 
of  preventing  competition,  III.  84-86. 

“What  the  traffic  will  bear,”  mean¬ 
ing  of,  under  monopoly  conditions 
and  under  competitive  conditions, 
III.  66— 68. 

Wheat  and  flour,  relation  of  rates  on, 
III.  164-165. 

Wheat-producing  areas,  disadvantages 
of  protective  tariff  to,  II.  112. 

White,  Money  and  Banking,  cited,  I. 
44. 

Woodlock,  book  by,  cited,  III.  3. 

Wool  industry,  protective  tariff  and, 
in  United  States,  II.  61 ;  an  illus¬ 
tration  of  the  establishment  of  a 
parasitic  industry  at  the  general 
expense,  65,  99-100. 


Printed  in  the  United  States  of  America. 


J 


Date  Doe 


JAN  IS ’33 

*9  . 

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OCT  l.fi'38 

SOU  2-38 

7-38 

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DEC  1 3'38 

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JAM  3 ’39 

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FEB  1*3 

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